Islamic Banking System

METHODOLOGY OF BANKING
H.A.D SANDARUWAN

UNDERGRADUATE OF WAYAMBA
UNIVERSITY,(BNF DEP)
STUDENT OF CMA / CA/IBSL
INSTITUTUES.TRAINEE OF AMANA BANK

CAMPUS TO CAREERS

C TO C
SPECIAL THANKS

o MR SHAHUL HAMEED THE MANAGER(AMANA BANK BADULLA
BRANCH)

o MR.ELMO FRANCIS - THE MANAGER (TRAINING &
DEVELOPMENT)

o MRS.THAKSHILA KUMARI - DEPT HEAD OF BANKING & FINANCE
(WUSL)

o THE STAFF MEMBERS OF AMANA BANK BADULLA BRANCH

Introduction

What is Money? (Meaning of Money)
The word money is used in everyday Conversation.
The modern economy is therefore called a monetary
economy.
Money plays an important and prominent role in the
economic life of the modern world.
But, define correctly what money is not easy.

Definition of Money
Money as anything that is generally accepted in
payment for goods and services or in the repayment of
debts.
" Money is anything used as a measure of value, a
medium of exchange and generally accepted by all.
'' Money is anything that is used as a measure of value,
a mode of payment, specially a medium of exchange, a
store of value and a means of deferred payment.

Barter System
Before the money came into operation there was
Barter system. Thus, Barter system was money less
economy. Its a simple economy where people
produced for self consumption.
In the early stages of societies trade was just
exchanging goods to goods, service to goods or service
to service. The hunter with more meat than he needed
would exchange his surplus for surplus fish of the
fisherman.
This system depend on the double coincidence of
wants

Double coincidence of wants
For an example X needs paddy and Y need a cow. For
an exchange of goods to take place between the two X
should have a cow and you should have a paddy. If not
the transaction would not take place. If the needs of
booth parties are satisfied, we call it double
coincidence of wants.
When social organizations more and more complex
and needs doubling and trebling the barter system
showed up its weakness.

Limitations Barter System
Without a double Coincidence of wants barter was
impossible- lack of double coincidence of wants.
In order to trade take place, the needs of the both parties
should coincide. Otherwise barter was impossible.
Valuation problem: The difficulty of assessing value of
each commodity was the inherent limitation of the
system. For an example how much of wheat should
be exchange for a cow. With the use of the money this
difficulty vanishes.

Waste of time though wants are the same. Till the
correct person is found one has to go about looking for
him .
Difficulties of credit transaction. In the barter system
debts have to be paid off by returning same
commodity
Difficulties of storing ones wealth. In the barter
system commodities take the place of money.
Prossessing wealth under this system in the same as
keeping commodities locked up. Storing of
commodities takes up a lot of space, and they perish
too soon. Goods are subjective to spoilage.

Indivisibility of certain goods. The barter system is
based on exchange of goods with other goods. It is
difficult to fix a exchange rate for other goods. Such
indivisible goods pose a real problem.
Lack of Specialization. High degree of specialization is
difficult under the barter system.
High transaction cost associated with barter system
led to the development of money as a medium of
exchange.
Development of Money

Economic Growth
Development of Money
Exchange- Trading
Specialization and division of labour
Transaction cost associated with
Barter
Evolution of Money
Barter System
Primitive Forms of Money
Metallic Money
Paper Money
Fiat Money
E-money
Functions of Money

$
Medium of Exchange
Unit of Account
Store of Value
Deferred payment
Properties of Money
Acceptable to people
Scarce and its supply controlled by the monetary
authority
Divisibility without any loss of value
Portability and not too heavy to carry
Recognisability and there is no confusion.

Demand for Money
People demand money for the following purposes:

Transaction Motive-lags between receipts and
expenditure
Precautionary Motives: for unforeseen expenses.
Speculative Motive: (Portfolio / Assets Demand): for
investment opportunities and earn profits

Money and Near Money
Money consists of currency issued by CBSL and
cheques of commercial bank.
Cheques and Bank drafts are perfect subsumes for
money and have high liquidity. This performs the
medium of exchange function of money.
But, time deposits are not real money and to become
money they must converted into cash or demand
deposits. This is called near money.
Near money serves as a store value function for a
shorter period are convertible into medium of
exchange in a short time without loss in their face
value.

What is a Financial Assets?
An asset is any possession that has a value to the owner.
It may be a physical possession ( land, building,
jewellery) or a claim on something or somebody ( a
mortgage, a loan or a deposit). It can be a intangible and
have significant value ( a goodwill).
A financial assets is an intangible asset that may be
defined as a claim that is expressed in terms of money.
By contrast real asset termed tangible and have physical
substance.
Both the financial asset and physical asset has generate
return for their owners.
Interest, profits, dividends- (cash flows)-FA
Sales revenue- P/A
Financial asset generates streams of cash flows
Mortgage Loans: interest income and repayment of
capital
Shares : dividends. Proceeds from sale of shares
Bonds: interest plus repayment of capital at maturity
Bank deposits: pay interest, withdrawal after
contractual period
Functions of Financial Assets
Functions of FA
Transfer of funds
Redistribute
unavoidable risk
Role of Money
Money is vital importance to the operation of the
national and international economy.
Role of money- Theory
Classical approach- money act as a medium of
exchange
Fisher Approach: MV=PT
Cambridge approach: Cash Balance approach: People like to
hold certain amount of money from their income as cash
balances. This explains the store value function of money.
Md = kPY
At equ; Ms = Md : Ms= kPY--------P = M/kY
k= 1/V
Ms = 1/VPY
MV = PY
Role of Money-Theory
Keynesian Theory- Three motives: Money demand as
an asset
Monetarists: Friedman approach
Friedman accept role of money as an asset and he
reformulate classical theory, so
QTM = CBA + Keynesian theory of Md
People demand money for wealth.

Md= f( P,Y, rb,re,rd) rb- rate of interest on bonds
re-rate of interest on equities
rd- rate of interest on durable goods

Social significance of role of money
Money is of vital importance to an economy due to its
static and dynamic role.
Static Role of Money: this explain the its functions. This
explains the role of money to overcome the problems of
barter system.
By serving as a medium of exchange money overcome the
problem of double coincidence of wants
By acting as a unit of account money becoms a common
measure of value.
Money act as a standard of deferred payment and removes
the problem of repayment in the barter system and
divisibility problem.
By acting as a store of value money removes the problem
of storing of commodities in the barter system

Dynamic role of money
To the consumer:
Money enables a consumer to make a rational
distribution of his income on various commodities of his
choice and maximize utility.
To the producer:
Money enables to producer to maintain all the records of
receipts and payments in monetary terms .
In specialization and division of labour
As the basis of credit: modern business is based on credit
and credit is based on money.

Definition
MS refers to the overall set of laws and practices which
control the quality of money in a country.
it is the standard money of the country which
determines and regulate the exchange value of goods
and services.
Thus, monetary standard of a nation is its standard
money.( or monetary system)
The monetary system is the way of currency of a
country is issued , managed and regulate
The evolution of the monetary system in the world is
evident that there were different types of monetary
standards used in the monetary system.
Types of Monetary Standard
Monetary
Standard
Metallic
Standard
Gold Coin
Gold
Bullion
Gold
Exchange
Gold
Reserve
Gold
parity
Monometallic
Bi- Metalism
Paper
Standard
Managed
Free
Exchange
Standard
Gold Standards
This is a monometallic standard
The countries standard of money is expressed in terms
of gold.
Gold coin Standards: oldest form
Gold Bullion Std: Gold Bars
Gold Exchange Std: external purposes
Gold Reserve Std: to maintain stability
Gold parity Std: modern version

Merits of Gold Standards
Inspired public confidence- domestic currency linked
with gold. Internationally accepted medium of exchange,
store value function
No outside interferences: work without any interference
by any country or institution.
Automatic operation: provide a simple and automatic
monetary system to the countries.
Stability exchange rate: maintained fixed exchange rates
between countries.
Stable Internal prices; it secured relative stability in
internal prices.

Check on inflation; since the currency of the country
liked with gold and convertible. Issue of currency is
backed by specific quantity of gold and limit the issue
of currency by the authorities.
Expansion of IT: stable ER and stable value of gold in
the countries led to expand the IT

Demerits of Gold Standard
Fair weather standard:
Not automatic
Exchange stability at the cost of economic stability
Deflationary bias
No independent policy
Costly standard

Paper Standard
After the breakdown of gold standard in 1931. All most all
the countries shifted to Paper standards.
It is the monetary standards in which inconvertible
paper money circulates as unlimited legal tender.
Before breakdown of GS this system was free.
But later, this is known as managed system since the qty
of money in circulation is controlled and managed by
the monetary authority.

Merits of t paper standard
Economical: cheaper than gold/ silver
Elastic: This is highly useful monetary system since it
possesses great elasticity. Monetary authority can easily
adjust the money supply in accordance with the
requirement of the economy. Freedom in the
management of money supply.
Price Stability: paper standard ensures price stability.
Can achieve price stability by maintaining equilibrium
through appropriate monetary policy.

Free from cycle effects: unlike other standards its free
from the business cycles arising in other countries. Cycle
movements can automatically transferred to other
countries through gold movements.
Full utilization of resources: monetary authority can
manipulate the monetary policy to ensure full
utilization of resources. But, in the gold standards, gold
outflows reduced prices d resources become
unemployed.
Portability: convenient to carry
easy to count and store
Replaceable: easy to replace by printing new

Demerits of the paper standards
Inflationary bias: his is a serious defects.
Price stability a myth.
Exchange rate instability: leads to ER instability due to
fluctuations external prices against internal prices.
Lack confidence
Lacks durability
Uncertainty
unstable

Financial Sector as at 2012
Sector Share of Total
Banking sector: 70.6
Other Deposit taking Inst. 6.9
(licensed finance corps.)
Specialized Fin. Institutions 3.1
Specialized leasing companies
Contractual Saving Ins. 19.4
Insurance, EPF, ETF, Authorized
Provident funds, public service
Provident funds
Total 100.00

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Role of a Financial System
What a financial system consisted of?
Who uses it and for what purposes?
The distinctive features of financial institutions
Distinctive features of financial markets
Why the performance of financial system is important
for rest of the economy

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Definitions
Financial system is:
A set of markets for financial instruments, and the
individuals and institutions who trade in those
markets
Who uses: people, firms, and organizations
What facilities offered: Intermediation between
surplus and deficit units
Financial services, payment mechanism, portfolio
adjustments
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Lenders and borrowers

Ultimate lenders Ultimate borrowers

Direct
Markets
Intermediaries

Income Savings = ? In the form of land, buildings or
machinery then what it is ?
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Possible uses of
Savings
what is NAFA?

Investment

Y C = S

Hoards
Lending

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Lending and Savings
Savings - Investment = financial surplus

Why financial surplus exists? Desire for holding
money

(Y- C) - Investment = NAFA (net acquisition of
financial assets
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Borrowing
When consumption is in excess of their income need
borrowing;
Those who want to spend in excess of their income are
said to have a financial deficit;
They have to either shed assets or incur liability debt.
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Priorities of Lenders and
Borrowers
Lenders Borrower
s
Returns + Cost --

Risk -- Length of
loan
+
Liquidity +
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Choice between debt and
investment
The amount of borrowing and lending one should
undertake to determine the exercising
Their portfolio choice:

When there is no further adjustment we say that the
people are in portfolio equilibrium
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Financial Institutions
Financial institutions are specialized in one or more of
the followings:
Providing payment mechanism
Providing means of borrowing and lending
Providing other services (insurance, foreign exchange)
What ever the functions, they mediate with financial
surplus and deficit

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Forms of financial institutions
Financial intuitions as firms:
Inputs, costs (fixed costs and variable costs), and
outputs. Derive revenue from outputs.
Maximizes profit when?
Financial Institutions as intermediaries:
Go between borrowers and lenders
What is the difference between brokerage and
intermediation?
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Financial Intermediation
Definition:
Financial intermediation: to create assets for lenders
and liabilities for borrowers which are more attractive
each than would be the case if the parties had to deal
with each others directly.
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Functions of Financial
Intermediation
Transformation of funds available to them for short
periods into loans available to ultimate borrowers.
Borrow short and lend long
What will be the effect without intermediation?

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Benefits from financial
intermediation
Maturity transformation
Availability of funds for longer periods
Pooling small deposits which are unattractive
Reducing risk of both lenders and borrowers
Reduce search and transaction cost
Bank modifies funds and creates; Assets, Liabilities, and
liquidity.

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Intermediation Process

Financial
intermediation
6/6/2014 53
Assets and liabilities
Liquidity:
1. Maturity transformation
(availability of funds for longer
periods)
2. Risk reduction
3. Search and transaction cost
reduction
4. Monitoring
Creation of Assets and Liabilities
Direct
lending
Lender Borrowing

Liability Asset Liability Asset
30,000 30,000
Total 30,000 30,000
Via
financial
intermediar
y
Intermediary

Borrower

Liability Assets Liability Assets Liability Assets
15,000 30,000
15,000
Total 30,000 30,000 30,000 30,000
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Example of a Bank balance Sheet
Assets in bn. Liabilities in
bn.
Cash in hand Sight and time
deposits
Market loans Savings
deposits
Bills Bonds and
bills
Bonds Loan from
other
institutions
Shares Capital
Advances
Total
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Financial System and the real
economy
Flow of funds Investment spending
Rate of Interest

Flow of funds
Rate of interest

Investment spending
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Functions of Financial System in Sri
Lanka
A stable financial system creates a favorable environment for depositors and
investors, encourages efficient financial intermediation and the effective
functioning of markets, and hence, promotes investment and economic
growth.

Financial system stability means the effective functioning of the financial
system (financial institutions and markets) and the absence of banking,
currency and balance of payments crisis.

Financial instability is caused by bank failures, excessive asset price volatility,
and collapse of market liquidity or a disruption to the payments system.

Financial system stability requires a stable macro-economic environment,
effective regulatory framework, well organised financial markets, sound
financial institutions and safe and robust payments infrastructure.
The maintenance of financial stability entails the prevention, detection and
reduction of threats to the financial system as a whole, through the surveillance
of markets and financial institutions, oversight of the payments system and
crisis resolution.
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Origin of Banking

Origin of banking evident from UK.
In the history of banking commercial bank came first.
Evolution of banks and development of trade go hand
to hand.
The word Bank revolves from the Italian word
banco.
In Italian market BANCO was where the merchants
deposited their gold for safe keeping until they decide
what they want to buy.
Origin of Banking
Mercantilism 16
th
17
th
centuries.
Emerged a class of people called Goldsmith
They are reliable people.
Security system convert to the system of Cash
Deposits.
The receipts issued by the Goldsmith later turnout to
be the paper money.
By providing depository services Goldsmith became as
the first Bankers.

Banking System in UK
Comprised with major three institutions
Joint Stock banks
London Money market
UK Central Bank
Bank Amalgamation Movements
Oligopolistic market
Branch Bank System
London Money Market Comprised with
Discount Houses
Clearing Houses
Investment banks
Bank of England
Building Societies
Big Bang Reforms- In 1986 commercial banks were
allowed to do investment banking activities.
UK Banking system
Retail Banking and Wholesale banking
UK Central bank- Bank of England
Maintain integrity and value of sterling
Maintain the stability of the financial system
Seeking to ensure the effectiveness of the UKs financial
services.
Banking System in USA
USA is a Federation.
Evolution of Banking system in USA: Three periods
can be highlighted
Colonial Experiments: Before 1775
American Revolution (1775-1783)
Free Banking Period: 1837-1863
Two- Tiered Banking System -1863
National Banking Act- 1863
Features of the Banking system in
USA and UK
Pure Banking System: if the banks provide either S/T
or L/T capital requirements
Mixed Banking System: both S/T and L/T capital
requirement
Branch Banking; system where each banks maintained
network of branches
Unitary Banking: one bank is attending all the banking
activities in the country

Progress of Banking System in Sri
Lanka

Banking system develop with the commercial agricultural
crop system.
Subsistence sector provide domestic needs of the public.
And totally neglected during the colonial period.
In Middle of 19
th
century was the proper period to locate
banking in Sri Lanka.
There are several stages in the development of
commercial banking in Sri Lanka.

Post Independence period
Government policy to improve non-traditional exports
Open economy in 1977 and afterwards

Post Independence period

Foreign Banks dominated the banking industry
post independence economy of Sri Lanka was solely
depend on plantation.
Import and Export Economy
Favorable situation in trade.
Foreign bank established branches with the expansion of
trading activities..
Exchange Banks: Money Transferring, trade financing.
General Public has no banking facilities
They borrow from CHETTIARS

Chettiars charge high rate for lending.
People expect a radical change in this system
Banking Commission was established in 1939.
As a result first domestic Bank established.
At the independence foreign banks dominated in the
banking Industry. Only two local banks operated.
Another important land mark of the history of banking in
SL was establishment of CBSL as an apex institution in the
financial system.

Open Economic Policies

Liberalization Policies
Washington Consensus
These measures basically focuses on free market
environment, that create conducive environment for
business.
NON Residence Foreign Currency Accounts
Establishment of FTZs
OFF-Shore Banking activities
Technological Improvement and Bank Marketing
Nationalization of Bank of Ceylon (1960) and
establishment of Peoples bank (1961).
Promoting Banking habits rural banking 1960s and
1970s
Domestic bank dominated banking Industry. Number
of foreign banks closed down their activities in Sri
Lanka.

Government policy to improve Non-Traditional
Exports

After independence foreign exchange earnings manly
depends on Traditional Exports.
Prices not stable. Trade balance deteriorated.
To overcome new concept developed: encouraging
NON TRADIONAL EXPORTS.
FEECS and CRA
FEEC: is a dual exchange rate system
CRA for imports

Globalization
Technological development: Innovation
Change in banking Philosophy with more customer
orientation.
Modern Banking Era : E- Banking

FINANCIAL SYSTEM & BANKING SYSTEM IN

SRILANKA
Overview of the Financial System
Financial
System
Central bank
Other
Regulatory
Institutions
Financial
markets
Financial
Institutions

Financial
Instruments
Infrastructure
Financial System in Sri Lanka
Institutional Approach
Monetary
System
Formal Sector
Monetary
Institutions
Monetary
Sector
Banking
Non- Monetary
Sector
Non-Banking
Financial
Markets
Informal sector
Money Lenders
Personal
Sources
Commodity
Based Savings &
Credit
Factor related
credit
Banking Sector
Banking
Sector
Central
Bank
Monetary
Policy
Commercial
Bank( LCB)
Domestic
Private
Foreign
State
Specialized Financial Institutions
Non-Monetary
Sector
Savings
Institutions
NSB, MBSL SB,
Sri lanka SB-3
Long Term
Lending
Institutions
DFCC, HDFC,
SMIB-3
Regional
Development
banks
Other Specialized
Financial
Institutions
Lankaputhra,
Pradeshiya DB,
Sanasa DB-3
Other Specialized Financial
Institutions (OSFI)
OSFI
Insurance
Companies
22
Merchant
Banks
11
Leasing
Companies
Finance
Companies
Venture
capital
Contractual
savings Ins
Unit trusts
Stock
Broakers
37
28
13
47
4
Financial Markets
Financial
Markets
Money
Equity
Debenture
Forex Futures
Option
Securities
Financial Instruments
Financial
Instruments
Deposits
Loans
Call money
T-Bills &
Bonds
Commercial
paper
Shares
Debentures
Bonds
Lease
Major Components of Financial
Infrastructure
Financial
Infrastructure
Cheque
Clearing
System
Fund
Transfer
Systems
RTGSS
SSSS
CBSL
Securities
Depository
System
Debt
Trading
System
Equity
Trading
System
Financial System- Flow of Funds

Financial system must provide a mechanism by which
funds flow from lenders to spenders.
Financial system vary country to country.
There are two fundamental transmission mechanisms
through which funds transfers from savers to investors.
through financial markets(directly)
Indirectly through intermediate markets via financial
intermediaries.

Direct and Indirect Finance
Indirect Finance

Direct Finance
Financial
Intermediaries
Investors
Spenders/Borrowers
Savers
Lenders
Financial Markets
Financial System- The Central Bank

Before the establishment of Central Bank in Sri Lanka
currency board system was managed monetary affairs of
the Island.
Not only Sri Lanka all colonies under the British rule
managed their money under currency board (1884- 1949).
CB had been functioning in SL since the enactment of the
Paper Currency Ordinance no 32 of 1884.
Members of the currency board system are:
Colonial secretary
The head of the treasury
The Auditor General

Main Functions of the CB System

The right to issue currency.
A full reserve to be maintained for the issue of
currency.
Linking the Sri Lanka rupee with the Indian rupee (
Called Reserve Money).
It had no power to influence the financial policy of the
country.
Money circulation under the currency board system
decided by the BOP position of the country

Limitations of the currency board
system
The currency board had no power to issue money to
meet the economic needs to the country.
Currency board was incapable of formulating financial
policy for the country. Because they had no capacity to
maintain favorable external and internal value of Sri
Lankan Rupee.
While this system favorable for foreigners who were
invested in plantation sector and it was unfavorable to
locales.

The agreement between the IMF and the Indian
government to use the gold par value for the Indian
Rupee.
Trade and exchange rate controls in the countries
weaker in the automatic link between Sri Lankan
Rupee and Indian Rupee weakened the established
link between SL rupee, Indian rupee and sterling..

Establishment of CBSL

Government invited John Exter, who was an economist
attach to the Federal Reserve System of U.S.A, to advice
upon the establishment of a central bank in Sri Lanka.
John Exter submitted a report, along with a draft bill, and
the bill was passed in to law as the Monetary Law Act
(MLA) no 58 of 1949.
The Central Bank of Sri Lanka was established under this
act and commenced its operation on August 28, 1950.

The currency board system was discontinued and
instead, a Monetary board was appointed to manage
the money supply. The volume of Sri Lankan rupee
issued no longer had to be directly linked to foreign
currency.

Structure of the CBSL

The CBSL has number of departments and divisions to
perform its activities. At the beginning of bank
commenced its operations in 1950, it consisted of only
five departments.
Banking and currency department
Public debt department
Exchange control department
Economic research department
Secretarial Department.

Structure of the CBSL

Over the years the bank has expanded to full fill better
its assigned role in the economy of Sri Lanka.
Functionally, the CBSL presently consist of 27
departments.
Bank Supervision Dept Management Audit Dept
Center for banking Studies Payment and Settlement Dept
Communication Dept Policy Review and Monitoring Dept
Currency Dept Facilities Management Dept
Domestic Operation Dept Provisional Officers Monitoring Dept
Economic Research Dept Public Debt Dept
EPF Dept Regional Development Dept
Exchange Controls Dept Secretariat Dept
Finance dept Security Services dept
Financial Intelligence Unit Statistics Dept
Financial Stability Studies Dept Supervision of Non bank Financial
Institutions Dept
Governors Secretariat Dept Welfare Dept
HRM Dept
Information Technology Dept
International Operations Dept

The CBSL is managed by the Monetary Board. The
monetary board is very much like board of directors of
a commercial bank. There are 3 members,
The Governor appointed by the President as
Chairman.
Three members nominated by the President to
represent private sector.
The secretary to the Minister of Finance, head of the
government finance.

Principle of the Central Banking

There is not more than one central bank in the country.
It has the power to control all commercial banks.
Unlike other banks the CBSL superior and independent
but not fully.
The principal on which a central bank is run differ from
the ordinary banking principals. its primary role towards
to promote financial and economic stability of the
country.

Vision

A credible and dynamic Central Bank
contributing to the prosperity of
Sri Lanka.

Mission

Maintaining economic and price
stability and financial system stability
to support sustainable growth through
policy stimulus advice, commitment
and excellence.
CBSL Objectives

Under MLA No. 58 of 1949
Stabilization Objectives
Stabilization of domestic monetary values
The preservation of the par value of the Ceylon Rupee and
the free use of the Rupee for current international
transaction.
Development Objectives

The promotion and maintenance of high level of
production, employment and real income
The encouragement and promotion of full development of
the productive resources.

Main Objectives of CBSL

As indicate recent amendments to the MLA(2002), the
Central Bank is changed with securing the objectives
of economic and price stability and financial system
stability.
In its efforts to achieve these objectives the CBSL
performs not only the traditional functions of a central
bank but also plays a development role.

Economic and Price Stability

This refers to the situation where there are no
fluctuations in the general price level in an economy
which helps to achieve sustainable economic growth.
Price stability facilitates to improve business confidence
since it reduces the uncertainty on future prices.
Such situations consumers and producers can make
economic decisions with confidence.
Low inflation foster sustainable long term growth and
employment.
Financial System Stability

FSS refers to the resilience of the financial system to
internal and external shocks.
Financial Instability reflected on the other hand through
the failures of Financial Institutions, collapse market
liquidity, assets price volatility.
Stability in the financial system creates favorable to
savers and investors.
Facilitate in the monetary policy transmission
mechanism and thereby to achieve price stability.

Efficient financial system encourages efficient
financial intermediation which in turn promoted
investment and growth.
Financial system stability ensures the effective and
efficient operation of markets and improve resource
allocation in the economy.
Causes of Financial system stability

A stable macro economic environment.
An efficient financial Markets
Safe and reliable payment and settlement system.
Well government and sound financial institutions,
Bank Failures
Excessive asset price volatility
Collapse of market liquidity
Disruption to the payment and settlement systems

The role of the central bank in financial system
stability

The central bank regulate and supervises banks and other
financial institutions and payment and settlement
systems to promote the financial system stability.
Legal provisions governing the regualtions and
supervisions are,
Monetary law Act
Banking Act
Finance Companies Act
Payment and Settlement systems Act
Exchange Control Act

Functions of CBSL
Functions can be explained as

Core Functions
Agency Functions
Core Functions
Conduct of Monetary Policy
Conduct of Exchange Rate policy
Management of foreign Reserves
Currency issue and Management
Supervision, Regulation and Licensing
Provide clearing and settlement facilities
Banker to the government
Agency Functions
EPF Management
Foreign Exchange Management
Public Debt Management
Regional Development
Financial Intelligence
Provincial Office Monitoring

General View of the CBSL Functions
Economic and Price Stability
Price stability means maintaining low, stable and
predictable level of inflation which leads to overall
macro economic stability through;
Improved efficiency of resources allocation
Enhance savings and investment
Effective long term planning
Sustainable economic growth and employment
Improving living standard of the public
One of the core objectives of the CBSL is maintaining
Economic and Price Stability.
Key to economic and price stability is effective conduct
of Monetary Policy.

o Monetary Policy refers to actions taken by the Central
bank to control the Cost (interest rates) and the
availability (Liquidity) of money.
o The main objective of the monetary policy is to
achieve price stability or keep inflation low and stable.

Central Bank Balance Sheet

General View
Assets
Securities (Treasury Securities)
Loans 9 Loans to commercial bank and credit to Govt.)
Gold and SDR Certificates ( issued by IMF)
Notes and Coins ( currency held by CBSL)
Cash items in the collection( arised from the CBSL
cheque clearing process)

Liabilities:
Currency in Circulation
Reserves (commercial bank reserves)
Treasury deposits( against with Treasury)
Foreign and other deposits ( Deposits with central bank
owned by foreign governments, institutions,
international agencies)
Deferred availability of cash items ( arised from clearing
process)
Other liabilities and capital.

CBSL Balance Sheet
Assets Liabilities
Loans to Commercial Bank (AKB) Currency Held by the public (CP)
Credit to Government (CGCB) Currency held by Commercial banks
(CKB)
International Reserves ( FACB) Deposits of KB with CBSL (RR)
Other Assets (OACB) Deposits of other Institutions (DOI)
Government Deposits with CB ( DGCB)
Foreign Borrowings (FBCB)
Other liabilities and Capital (OLCB)
Reserves
Reserves
Central Bank
Reserves
Foreign
Reserves
Commercial
Bank Reserves
Required
Reserves (SRR)
Excess
Reserves
Reserve Money

Reserve Money can be identified by looking at the balance
sheet of the Central Bank.
This can be defined basically in two ways
Based on financial liabilities of the CBSL (Use Basis):
Currency held by the public and Commercial bank (CP,
CKB)
Deposits of commercial bank with CBSL (RR)
Deposits of other Institutions with CBSL ( DOI)
MB = CP + CKB + RR + DOI

Reserve Money
Based on Net Financial Assets (source Basis) held by
CB
Loans to commercial banks (AKB)
Credit to Government (CGCB)
Net Foreign Assets( FACB- FBCB)
Other Assets (Net)- (OACB OLCB)

Base Money = Net Domestic Assets of CBSL + Net
Foreign assets of CBSL

Reserve Money

MS = MB * mm
Money Supply = Monetary Base + Money Multiplier
MB = MS / mm
Money supply is the product of Monetary base and
money multiplier.
mm denotes the rate at which the commercial bank
are able to create multiple deposits and credits.
Money Multiplier- properties of
mm
mm>1 : If m equal to one then it is not a multiplier.
Money supply is equal to the quantum of monetary
base. This implies that commercial banks cannot
create multiple credits and deposits and they are like
any other finance company. Money multiplier cannot
be less than one, as it means any increase in reserve
money will lead to reduction in the money supply
CKB/TD + RR/TD <1:Similarly if
CKB/TD + RR/TD = 1, it indicates that commercial
banks do not grant any loan but
simply hold the all the deposits in reserves.

Let us examine the significance of the components in
the money multiplier : CP/TD, CKB/TD, RR/TD

CP/TD This shows the preference of the public to
hold currency as against the bank deposits. Any
increase in the ratio will result in a decrease in the
money multiplier. In a primitive economy majority of
transactions are carried out in cash form and this ratio
is relatively higher than in a developed economy.

CKB/TD This represents the level of cash held by
commercial banks to service their deposit liabilities
when this ratio increases lower the money multiplier
and there by it lowers the credit creating capacity of
commercial banks.
RR/TD - This shows the statutory reserve
requirement imposed by the central bank. When the
ratio is raised money multiplier will fall.

Central Bank and conduct of Monetary
Policy

Monetary policy is the means whereby a central bank
attains price stability in the domestic economy by
regulating the cost and the availability of money.
The difinition of money supply, which is the main
variable considered in determining monetary policy.
And that was redefined in view of the development of
the financial structure, changing financial sector, and
change in financial instruments.
Monetary Aggregates
Item M1 M2 M2b M4
Currency held by the public X X X X
Demand deposits held by the public X X X X
Time and savings deposits held by the public X X X
T & S deposits held by the public with FCBU X X
T & S deposits held by the public with LSBs X
T & S deposits held by the public with Finance
Co.
X
Monetary policy framework &
Monetary Program

Framework: monetary targeting or targeting monetary
aggregates.
Monetary Program: Presents path of monetary expansion
which is consistent with projected macroeconomic
outlook, expected growth and inflation rate.
Development in all four sectors of the economy are taken
into account when preparing monetary programme
namely real sector (GDP), Monetary sector(
Inflation),External Sector( BOP), Fiscal Sector ( Net
CREDIT to GOVT)
Monetary Targeting in Sri Lanka
Since early 1980s monetary management in Sri
Lanka is based on monetary targeting framework.
Price stability is to be achieved by influencing
changes in broad Money supply, which is linked to
monetary base through a multiplier.
Reserve Money is the operating target of monetary
policy.
The monetary targeting framework is operated
through a monetary programme.
Monetary Targeting in Sri Lanka
Policy
Instruments

Operating
target
Reserve Money
Intermediate
target
Broad Money

Final Objective
Monetary Policy Instruments

Policy Interest rates: Currently 7% & 9%
Open market Operations
SRR (6%)
Quantity restrictions
Bank Rate (15%)
Margin Requirements
Refinance Facilities
Moral Suasion

IMPORTANCE OF PROMPT CUSTOMER
SERVICE
Customer service could be considered the most
important job in a bank.
The customer is always right! This statement
is true in every business.
One unhappy customer can taint the reputation of
a business by telling everyone they know about
their bad experience.
Good customer service people are a valuable asset
to any business
BANK TELLER
How Does This Apply to Banking?
All banking customers will come in contact with at
least one of the following customer service positions:
BANK TELLER
NEW ACCOUNT REPRESENTATIVE
LENDING REPRESENTATIVE
BOOKKEEPING REPRESENTITIVE
Considered a "front line" in the banking business.
The first person a customer sees
Most likely to detect and stop fraudulent
transactions
Required to be friendly and interact with the
customers
Provide information about customers' accounts
and bank services.
bank teller is
Bank Teller: Responsibilities
The role of a bank teller requires organizational and
time management skills.
The duties and responsibilities are wide in scope.
The following slides will give you a glimpse into the
everyday tasks of a bank teller.
Bank Teller: Cashier
Prepare deposit slips
Cash checks
Verify endorsements
Tender cash
Balance cash drawer
Bank Teller: Distributor
Issue cashiers checks
Savings bonds
Money orders
Travelers checks
Bank drafts
Cash advances
Bank Teller: Helper
Facilitate usage of safe deposit boxes
Respond to balance inquiries
Transfer funds between accounts
Bank Teller: Security
detect and report counterfeit money
conduct customer identification procedures
Bank Teller: Sales
Recognize customer motivation and buying behavior
Implement sales promotion, selling and service
distribution components of banks marketing plan
NEW ACCOUNTS
REPRESENTATIVE
A new account representative.

Have good communication, verbal
communication and listening skills and problem-
solving skills
Able to work independently
Respond to customer inquiries and make sure
problems are resolved.
Handle complaints in accordance with bank
policies.
Fix problems or suggest solutions.
Customer Service Rep.:
Records Keeper
Record customer information
Issue customer signature cards for accounts
Issue safe deposit box.
Customer Service Rep.:
Sales
Analyze customer needs
Implement sales promotion
Selling and service distribution components of banks
marketing plan
LOAN OFFICERS
A loan officer
is an important customer service representative
for any financial institution. They have the task
of finding potential clients and helping them to
apply for loans.
They usually specialize in commercial, consumer,
or mortgage loans.
And they guide clients through the process of
applying for a loan.
Loan Officer: Marketing
Implement sales promotion,
Selling and service distribution components of banks
marketing plan
Loan Officer: Decision Maker
Analyze best loan alternative for customer
Obtain written loan application and credit
report
Evaluate collateral
Approve/deny loan application
Obtain required signatures
Disburse loan funds

BOOKKEEPERS
A bookkeeper
handles all financial recordkeeping.
posts debits and credits, produce
financial statements, and prepare
reports and summaries for managers.
also prepares bank deposits. They verify
and balance receipts.
sends cash and checks also may handle
payroll and make purchases
might prepare invoices and keep track
of overdue accounts.
Bookkeeper: Behind the Scene
Post and balance general ledger
Process stop payments
Prepare bank statements
Process NSFs (non-sufficient funds)
Encode transactions
Transmit proof data to processing center
Prepare balance settlement
Process return items

Bookkeeper:
Customer Contact

Assist customer with account reconciliation

A bookkeeper will sometimes act as a teacher by helping customers learn how to
reconcile a check register in order to keep a good checking record which will
help in keeping a good credit rating.

Importance of KYC Requirement
Know your customer (KYC) refers to relevant
information from their clients for the purpose of doing
business with them. The term is also used to refer to
the bank regulation which governs these activities.
Know Your Customer processes are also employed by
companies of all sizes for the purpose of ensuring their
proposed agents', consultants' or distributors' anti-
bribery compliance. Banks, insurers and export credit
agencies are increasingly demanding that customers
provide detailed anti-corruption due diligence
information, to verify their probity and integrity

With this knowledge the Bank is better able to detect
fraud, unusual or suspicious activity, and mitigate other
types of risks. KYC also protects the Bank in that it
ensures that the Bank is not, at least knowingly,
facilitating or encouraging money laundering or
undermining the integrity of the financial system.
Know your customer (KYC)
Who is a customer?
One who maintains an account,establishes business
relationship on whos behalf account is maintained by
intermediaries & one who carries potential risk
through one off transaction.

What should you know of the
customer?

True identity & beneficial ownership of the A/c s
Permanent address,registered & administrative
address
Making reasonable efforts to determine the true
identity & beneficial ownership of accounts
Sourses of funds
Nature of customers business
Politically exposed person
KYC DOESNT MEAN
Denial of service to the common person
Intrusive behavior
Use of information for cross selling
Harassment of customers
threatening to closedown the accounts
arbitrarily

KYC POLICY IDENTITY,VERIFY,MONITOR
WHAT IS KYC

Identity the customer
Verify the customer
Monitor the customer

WHAT IS CDD
Update of information of the customer obtained
through KYC ( including new information)

Transformation of KYC data into information

ADVANTAGES OF KYC NORMS
Sound kyc procedures have particular relevance to
the safety & soundness of ABL in that,
They help to protect ABLS reputation & the
integrity of banking systems by reducing the
likelyhood of ABL becoming a vechicle for or a
victim of financial crime & suffering
consequencial(reputational)damage.

CORE ELEMENTS OF KYC

customer acceptance policy
customer identification procedure- customer profile
risk classification of accounts - risk based approach
risk management
ongoing monitoring of account activity
reporting of cash & suspicious transactions.

Cash operations
Tellers Functions
Money deposits
Money Withdrawal
Cheque Withdrawal
Foreign Currency exchange

Atm cash transactions
(1)Cash loaded to atm
Atm a/c debit
Cash in hand credit

(2)Cash remaining atm
Cash in hand debit
Atm a/c credit
Vault cash transactions
Cash transfer to vault
Main vault debit
Cash in hand credit

Cash transfer from vault
Cash in hand debit
Main vault credit

Idenifying Atm cash loading
Cash dispenser
Total rejected = all amount of cash rejected
Diverted = all diverted amount
Retracted = atm card retracted
Cassete
Dispensed = withdrawal amount
Remaining = available balance
Rejected = fade notes reject amount
Diverted = divert when self test
Negotiable Instrument
a negotiable instrument means a promissory note, bill of
exchange or cheque payable either on order or to bearer.

An instrument may be negotiable either by
1. Statute : Promissory Notes , bills of exchange and cheques
are negotiable instruments under Negotiable Instruments
2. By Usage : Bank Notes , Bank Drafts , scripts, treasury
Bills etc

Transfer by Negotiation
Negotiation is a transfer of an instrument from one
person to another in such a manner as to express
title & to represent the transferee the holder
thereof.
Passing of possession
With intention to pass title
Must be transferred in such a manner that the
transferee becomes holder thereof.

Methods of Negotiation
1. Negotiation by delivery
2. Negotiation by endorsement & delivery
3. Property is transferred to the endorsee
4. Endorsee get right to negotiate the instrument, sue on
instrument.
Characteristics
It is freely transferable
Better title
Right to sue
A negotiable instrument can be transferred any number of
times till its maturity
A negotiable instrument is subject to certain presumptions
Presumptions certain presumptions as to consideration,
reasonable time etc., apply to all negotiable instruments.

Presumptions
1. Consideration : Every negotiable instrument is deemed
to have been drawn and accepted , endorsed, negotiated,
or transferred for consideration
2. Date : Every negotiable instrument must bear the date
on which it is made or drawn
3. Acceptance : Every Bill of exchange was accepted within
a reasonable time after the date mentioned therein and
before the date of its maturity
4. Transfer : Every transfer should be made before the
expiry

Meaning of Endorsement
When a maker or holder writes the persons name on the
face or back of the instrument & puts his signatures thereto
for the purpose of negotiation, it is called endorsement.
Person who signs endorser
To whom it is endorsed endorsee.
A legal term that refers to the signing of a document which
allows for the legal transfer of a negotiable from one party
to another.
When an employer signs a check, they are endorsing the
transfer of money from the business accounts to the
account of the employee.
Essentials of valid endorsement
1. On the back or face of the instrument.
2. Must be made by maker or holder.
3. Must be properly signed by the endorser.
4. It must be for the entire negotiation instrument.
5. No specific form of words are necessary for endorsement.
Kinds of endorsement
1. Blank or general endorsement where endorsee simply
puts his signature on the back of the instrument without
writing name of the person in whose favor the instrument
is endorsed.
2. Special or full endorsement An endorsement with the
direction to pay amount mentioned in the instrument to a
specified person or his order & the endorser writes his
signature under it.
3. Partial endorsement When an endorser is willing to
transfer to an endorsee only a part of the amount of the
instrument. Such an endorsement does not operate as a
negotiation of the instrument.

The instrument is therefore payable to the bearer
Restrictive endorsement An endorsement is said to be
restrictive if it prohibits or restricts the further
negotiability of the instrument. The holder of such an
instrument can only receive the payment but he cannot
negotiate it further. An instrument can be made restrictive
only by expressed words.
Conditional endorsement It limit the liability of the
endorser. E.G. Pay A or order on his marrying B.

Effects of Endorsement
The property in instrument is transferred from
endorser to endorsee.
The endorsee gets right to negotiate the
instrument further.
The endorsee get the right to sue in his own name
to all other parties.

Promissory Notes
Section 4 defines it as, A promissory note is an
instrument in writing containing an unconditional
undertaking, signed by the maker, to pay a certain sum of
money only to or to the order of a certain person or to the
bearer of the instrument.
The person who makes the promissory note is called the
maker.
The person to whom payment is to be made is called the
payee. e.g.
I promise to pay B or order rs. 500
I promise to pay B Rs.500 on D death, provided D leaves
me enough to pay that sum
Essentials of Promissory Note It must be in writing
It must contain express promise to pay :- I am liable to pay
The promise to pay must be unconditional
It must be signed by maker
The maker must be certain- It must describe the name &
designation of the maker, sum of money
There are 2 parties involved i.e. maker and the payee
The payee must be certain- It is essential that it must contain a
promise to pay some person ascertained by name or designation.
The sum payable must be certain
The payment must be in legal money
A currency note is not a promissory note

Bill of Exchange
Section 5, is defined as A bill of exchange is an instrument in
writing containing an unconditional order, signed by the maker,
directing a certain person to pay a certain sum of money only to
or to the order of a certain person or to the bearer of the
instrument.

Parties to bill of exchange :
Drawer The person who makes/orders to pay bill of exchange.
Drawee The person who is directed to pay on bill. On
acceptance he becomes acceptor.
Payee The person to whom the payment is to be made.
Drawer & Payee can be the same person.
X sells goods worth Rs. 2000 to Y & allow him 3 months time to
pay the price. X then draws a bill on Y Three months after date,
pay to my order the sum of Rs. 2000 for value received. X is
drawer . Y is Drawee.

Essential of Bills of Exchange
It must be in writing
It must contain an order to pay and a promise or request
The order must be unconditional
There must be 3 parties i.e. : drawer, drawee, and payee
The parties must be certain
It must be signed by the drawer
Number, date and place are not essential
Cheques
Section 6, defines it as A cheque is a bill of exchange
drawn on a specified banker & not expressed to be payable
otherwise than on demand.
It is always drawn on a bank
It is payable to bearer on demand

Parties To Cheque:
1. Drawer who makes the cheque
2. Payee to whom payment is to be made
3. Drawee Bank .

Meaning of Crossing of Cheque
Crossing of a cheque is a unique feature associated with a
cheque affecting to a certain level the responsibility of the
paying Banker and also its negotiable Character.
Crossing of a Cheque is a direction to a particular Banker
by the Drawer that Payment should not be made across the
Counter. The payment on the crossed Cheque can be
collected only through a Banker.
Crossing of the Cheque is affected by drawing two parallel
Transverse lines .
The Cheque that is not crossed is an open Cheque.

Types of cheque
There are two types of cheque:
1. Open cheque those which can be en cashed across the
counter of the bank. Liable to great risk if stolen or lost.
Finder can get payment from bank.

2. Crossed cheque which bears two transverse lines with or
without the words & co.

Various kinds of Crossing
1. General Crossing:- which bears across its face the words
& co. or the words not negotiable. For general crossing
two transverse lines on the face of cheque are essential.
The paying banker shall pay only to a banker. There are
two sloping parallel lines, marked across its face
The cheque bears an short form "& Co. "between the two
parallel lines
The cheque bears the words "A/c. Payee" between the
two parallel lines.
The cheque bears the words "Not Negotiable" between
the two parallel lines.
Specimen of General Crossing
2. Special or Restrictive Crossing :- When a particular bank's
name is written in between the two parallel lines the cheque is
said to be specially crossed. Where a cheque bears across its face
an addition the name of banker either with or without the words
not negotiable. It contains:
The name of the banker across the face of cheque.
With the words not negotiable
In addition to the word bank, the words "A/c. Payee Only", "Not
Negotiable" may also be written. The payment of such cheque is
not made unless the bank named in crossing is presenting the
cheque. The effect of special crossing is that the bank makes
payment only to the banker whose name is written in the
crossing. Specially crossed cheques are more safe than a generally
crossed cheques.
Specimen of Special or Restrictive
Crossing
Why Crossing of Cheque is being
used
The important usefulness of a crossing cheque is that it cannot
be covered at the counter but can be collected only by a bank
from the drawee bank.
Crossing provides a protection and safeguard to the owner of the
cheque as by securing payment through a banker it can be easily
detected to whose use the money is received. Where the cheque is
crossed the paying banker shall not pay it except to a banker.
In case of not negotiable crossing the person holding such a
cheque gets no better title than that of his transfer and cannot
suggest a better title to his own transferee. In case of 'account
payee' only crossing, a direction is given to the collecting banker
to collect cheque and to place the amount to the credit of the
payee only.
A special crossing makes the cheque more safe than a general
crossing because the payee or holder cannot receive payment
except through the banker named on the cheque.

Who can cross a Cheque
1. The drawer of a Cheque
2. Holder of the Cheque
3. The Banker in whose favor the cheque has been crossed
specially
Promissory Note Bill of Exchange
1. It contains a promise to pay.
2. It is presented for payment
without any previous
acceptance by the maker.
3. It cannot be made payable to
the maker himself. The maker
and the payee cannot be the
same person.
4. In the case of a promissory
note there are only two
parties, the maker and the
payee.
5. A promissory note can never
be conditional.
6. In case of dishonour no notice
of dishonour is required to be
given by the Holder
1. It contains an order to pay.
2. It is required to be accepted either
by the drawee or by some one else
on his behalf, before it can be
presented for payment.
3. The drawer and payee or the
drawee and the payee may be the
same person.
4. There are three parties, drawer,
drawee and payee.
5. A bill of exchange cannot be
drawn conditionally, but it can be
accepted conditionally with the
consent of the holder.
6. A notice of dishonour must be
given in case of dishonour of a
Bills of Exchange.
Cheque Bill of exchange
1. Drawee: Cheque can be drawn
only on a banker.
2. Time of payment: A cheque is
payable on demand.
3. Grace period: Cheque is payable
on demand and no grace period is
allowed.
4. Notice of dishonour: Notice of
dishonour is not necessary.
5. Acceptance: A cheque is not
required to be presented for
acceptance. It needs to be
presented only for payment.
6. Crossing: A cheque may be
crossed.
7. Validity period: A cheque is
usually valid for a period of six
months.

1. The drawee may be any person.
2. A bill may be drawn payable on
demand or on expiry of certain
period after date or sight.
3. While calculating maturity three
days grace is allowed.
4. A notice of dishonour is required.
5. Bills require presentment for
acceptance and it is better to
present them for acceptance even
when it is not essential to do so.
6. A bill of exchange cannot be
crossed.
7. A bill may be drawn for any
period.
Contents
Meaning & Definition
Specimen of Cheque
Essentials of a Cheque
Types of Cheques
Endorsement of Cheques
As a Paying Banker
Dishonour of Cheques
As a Collecting Banker

Meaning and definition
Section 6 defines a cheque as A bill of
exchange drawn on a specified banker and
not expressed to be payable otherwise than
on demand and it includes the electronic
image of a truncated cheque and a cheque
in the electronic form.

Thus a cheque is also a bill of exchange with three
additional qualifications:
(a) It is always drawn on a specified banker.
(b) It is always payable on demand.
(c) It includes the electronic image of a truncated
cheque and also a cheque in electronic form.

In other words, "Cheque is an instrument in writing
containing an unconditional order, addressed to a
banker, sign by the person who has deposited
money with the banker, requiring him to pay on
demand a certain sum of money only to or to the
order of certain person or to the bearer of
instrument."

Specimen of a cheque
Essentials of a Cheque

The essential features of a cheque are:
1. A Cheque must be in writing. The writing may be by
means of a pen, a type-writer, printed characters, ball-
pen or even pencil because law has not specified the
writing materials with which a cheque has to be written.
2. Cheques must be in form of a order and not in form of a
request.
3. The order must be unconditional. If any condition is
attached with the order, the cheque will lose its legality.
4. The Amount demanded must be for certain amount in
money and not in kind.
5. The payment must be made to a certain person, bearer
or self.
6. It must be drawn on a banker.
7. It must be signed by the account holder.
Types of Cheques

Different types of cheques are:
Bearer Cheque
Order Cheque
Uncrossed/Open Cheque
Crossed Cheque
Anti-Dated Cheque
Post-Dated Cheque
Stale Cheque

Types of cheques
1. Bearer Cheque
When the words "or bearer" appearing on the face of the
cheque are not cancelled, the cheque is called a bearer
cheque. The bearer cheque is payable to the person
specified therein or to any other else who presents it to
the bank for payment. However, such cheques are risky,
this is because if such cheques are lost, the finder of the
cheque can collect payment from the bank.

Types of cheques
2. Order Cheque
When the word "bearer" appearing on the face of a
cheque is cancelled and when in its place the word "or
order" is written on the face of the cheque, the cheque is
called an order cheque. Such a cheque is payable to the
person specified therein as the payee, or to any one else
to whom it is endorsed (transferred).

Types of cheques
3. Uncrossed / Open Cheque
When a cheque is not crossed, it is known as an "Open
Cheque" or an "Uncrossed Cheque". The payment of
such a cheque can be obtained at the counter of the
bank. An open cheque may be a bearer cheque or an
order one.

Types of cheques
4. Crossed Cheque
Crossing of cheque means drawing two parallel lines on
the face of the cheque with or without additional words
like "& CO." or "Account Payee" or "Not Negotiable". A
crossed cheque cannot be encashed at the cash counter
of a bank but it can only be credited to the payee's
account.

Types of cheques
5. Anti-Dated Cheque
If a cheque bears a date earlier than the date on which it
is presented to the bank, it is called as "anti-dated
cheque". Such a cheque is valid upto three months from
the date of the cheque.

Types of cheques
6. Post-Dated Cheque
If a cheque bears a date which is yet to come (future
date) then it is known as post-dated cheque. A post
dated cheque cannot be honoured earlier than the date
on the cheque.
7. Stale Cheque
If a cheque is presented for payment after six months
from the date of the cheque it is called stale cheque. A
stale cheque is not honoured by the bank.

Endorsement of Cheques
Endorsement of a cheque means sisgning ones name
either on the back of a cheque or on its face or on a slip
of paper called the allonge for the purpose of
transferring the interest, right, property or title in the
cheque to another person. The person who endorse
the cheque is called the endorser of the cheque. The
person to whom the cheque is endorsed is called the
endorsee of the cheque.

Endorsement of cheques
Kinds of endorsement:
Blank Endorsement or General Endorsement
Full endorsement or Special Endorsement
Restrictive Endorsement
Sans Recource Endorsement
Conditional Endorsement or qualified Endorsement
Faculative Endorsement
Sans Frais Endorsement

Blank Endorsement
It is an endorsement in which the endorser merely signs his
name on the back of the instrument without mentioning the
name on the back of the instrument without mentioning the
name of the person to whom the instrument is endorsed.

Special Enorsement
It is an endorsement in which the endorser writes not only
his name, but also the name of the person to whom the
instrument is endorsed on the back of the instrument.

Restrictive Enorsement
A restrictive endorsement is one which, limits the
further negotiation of an instrument. The endorsee in
such cases, cannot further endorse it. Generally, the
word only is added after the endorsees name.
Sans Recourse Endorsement
It is an endorsement which limits the liability of the
endorser. The effect of this endorsement is, to render the
endorser free from all liability to any subsequent holder.

Conditional Endorsement
It is an endorsement in which the endorser makes his liability
on the instrument or the right of the endorsee to receive the
payment of the instrument depend upon the happening of a
specified event.
Faculative Endorsement
It is an endorsement whereby , the endorser waives some of
his rights on the instrument.
Sans Frais Endorsement
It is an endorsement in which by writing the words Sans
Frais, the endorser makes it clear that no one should incur
any expense on his account in respect of the negotiable
instrument.

Paying banker
Meaning:
The banker on whom the cheque Is drawn or the banker
who is required to pay the cheque drawn on him by a
customer is called the Paying Banker or Drawee
Banker.

Paying banker
Precautions to be taken by a paying banker:
1. He should see that the cheque is drawn in proper form
and satisfies all the requirements of a valid cheque.
2. He Should verify whether the cheque is dated or not.
3. He should satisfy himself that the amount payable is
certain.
4. He should see whether there is sufficient amount in the
bank account.
5. The banker should see whether the cheque is signed by
the drawer.

Paying banker
6. The banker should see whether the cheque is drawn
on the same branch of the bank in which the drawer
has his account.
7. When a cheque is presented to him at the counter,
the paying banker must verify whether it is an open
(i.e., Uncrossed Cheque or Crossed Cheque).
8. The Banker should see whether there is any material
alteration in the cheque.
9. When a cheque presented for payment is mutilated,
he should check whether it is intentional or
accidental.
Protection to paying banker
The paying banker is given some statutory protection
in respect of risks or difficulties faced by him.

The protection to the paying banker is laid down
in Section 85(1), 16(2), 85(2), 85A, 89 and 128 of the
Indian Negotiable Instruments Act of 1881.

Protection to paying banker
Protection in respect of an Order Cheque Bearing Forged Endorsement of the Payee.
(1) The endorsement of the payee must be regular or correct.
(2) The payment must be a payment in due course.
Protection in respect of an Order Cheque Bearing Forged Endorsement of the Endorsee:
(1)The endorsement of the endorsee must be regular or correct, but
not necessarily be genuine.
(2)The payment must be a payment in due course.
Protection in respect of a Bearer Cheque.
(1)There is nothing to arouse suspicion about the bearer of the cheque.
(2)The payment is made to the bearer in due course.
Protection in respect of an Order Draft Bearing Forged Endorsement.
(1) The endorsement on the draft must be regular or correct.
(2) The payment must be a payment in due course.

A cheque is said to be dishonoured when it is not
paid by the paying banker on presentation.

Circumstances under which a customers Cheque can be
Dishonoured:
1. When the cheque is a conditional one, the paying banker can dishonour that
cheque.
2. When the customer countermands the payment of any cheque, the banker
must refuse to make the payment for that cheque.
3. When the banker receives a notice from the holder about the loss of the
cheque, he cannot ignore that notice and make the payment.

4. On receipt of a notice of the drawers death, the banker must stop the payment
of cheques issued by the drawer. This is because the order of the drawer to the
banker to pay any cheque ceases to operate after his death.
5. When the banker receives a notice of the drawers insolvency, he must
dishonour the cheque issued by the customer. This is because after a customer
is declared insolvent, his properties, including his bank balance, vest in the
official assignee or official receiver, as the case may be.
6. When a garnishee order is served on the banker by a court attaching the
customers funds, the banker is bound to comply with the garnishee order.
7. If the bank account is a trust account and if the banker comes to know that the
customer, who is operating the trust account, intends to use the funds in the
trust account in breach of trust for his personal use, the banker must stop
payment for the cheques issued by the said customer or trustee.

8. If a cheque is presented for payment after the customers account is
closed, the banker must refuse payment for a cheque.
9. When a cheque is not signed by the drawer, the banker must not
make the payment for such a cheque.
10. When a crossed cheque is presented at the counter for payment, the
banker must not make the payment for that cheque.
11. If the drawer is a foreigner, and if there is an outbreak of war with
the drawerss, country, the banker must refuse payment for the
cheques issued by that customer during the time of war.
12. When the funds to the credit of a drawer are insufficient to meet the
cheque issued by him, the banker may refuse payment.
13. When the drawers signature on the cheque differs from his
specimen signature, the banker may refuse payment for the same.
14. When a cheque is undated, the banker may refuse payment.
15. Where a cheque bears an incomplete date, the banker may refuse
payment.

16. Where a cheque bears an incomplete date, payment may be refused by the
banker.
17. If a cheque has become stale, payment may be refused.
18. If a cheque is presented for payment outside banking hours, payment may be
refused.
19. When the endorsement of the payee or the endorsee on a cheque is irregular,
the banker may refuse payment.
20. If the amount of the cheque stated in words differs from the amount stated in
figures, the banker may refuse payment.
21. If the amount of a a cheque is stated only in figures, payment may be refused.
22. If a cheque is not drawn in proper form, the banker may refuse payment.
23. If the cheque is ambiguous, i.e., not clearly written, payment may be refused.
24. If a cheque bears any material alteration, the banker may refuse the payment.
Statement of reasons for dishonour
N.S (Not Sufficient): The answer means that the funds to the credit of the drawer
are not sufficient to meet the cheque.
N.F (No Funds): This anwer means that there are no funds in the drawers account
to pay the cheque.
N.A.F (Not Arranged For): This answer means that the cheque has been drawn
against an overdraft which has not been arranged.
E.A (Exceeds Arrangement): This answer means that the payment of the cheque
would result in the overdraft exceeding the limit sanctioned.
D.R (Discharge Required): This means that endorsement is required.
D.D (Drawer Deceased)
Drawer Insolvent
Drawer Insane
No Account
Account Closed
Statement of reasons for dishonour
Cheque irregularly drawn
Cheque is post dated
Cheque is stale or out of date
Cheque is mutilated
Payment stopped under court order
Drawers signature differs
Alteration requires drawers signature

Collecting banker
The collecting banker is the banker who collects cheques drawn upon other
bankers for and on behalf of his customers. He is called the collecting
banker, as he undertakes the work of collection of cheques.

Procedure Followed in collection of cheques:
First, he recieves from his customer the cheque which is required to be collected.
Then, he presents that cheque to the drawee or paying banker either through clearing
or thrrough post for payment.
If the cheque presented to the paying banker is honoured or realised, he credits the
amount realised to his customers account, and informs the customer about it.
If the checque is dishonoured, he gives notice to his customer about the dishonour of
the cheque.

Collecting banker
Legal Status of a collecting banker:
Collecting Banker as a Holder for Value:
A Collecting banker becomes a holder for value, if he has paid the value of
the cheque to the customer before the cheque is actually collected. In other
words, a collecting banker becomes a holder for value, when he collects his
customers cheque for himself, and not for the customer.
Collecting Banker as an Agent of His Customer:
A Collecting banker collects a cheque as an agent of his customer, he has no
rights of his own. His rights or tilte to the cheque will be the same as that of
the customer. If his customer has a good title to the cheque, he too will have a
good title to the cheque.
Protection to collecting banker
The protection to the collecting banker is laid down in Sections 131 & 131A of the
Indian Negotiable Instruments Act of 1881.
The Section 131 states:
A banker who has in good faith and without negligence, received payment
for a customer, of a cheque crossed generally or specially to himself, shall not,
in case the tilte to the cheque proves defective, incur any liability to the true
owner of the cheque by reason only of having received such payment.

It means, A banker recieves payment of a crossed cheque for a customer within
the meaning of this section not withstanding that he credits his customers
account with the amount of the cheque before receiving the payment thereof.

The protection given under section 131 can be claimed by the collecting
banker only if the following conditions are satisfied:
1. This protection is available only for a crossed cheque. No protection
is granted for an open or uncrossed cheque, as it need not be collected
through a banker.
2. This protection can be claimed only for that cheque which has been
crossed before it reaches the collecting banker.
3. This protection can be claimed only when the collecting banker has
collected the cheque as an agent for his customer
4. This protection can be claimed only if the collecting banker has
collected the cheque in good faith and without negligence.

Protection in respect of Bank Drafts:
Section 131A of the Negotiable Instruments Act of 1981 gives protection to the collecting banker
in respect of a draft, bearing a forged endorsement or in respect of a draft to which the customer
has no title or defective title. The protection given under Section 131A can be claimed by the banker
only if all the conditions laid down in section 131 are satisfied.
Protection is respect of Bills of Exchange:
The statutory protection given to a collecting banker in respect of cheques and bank drafts under
Section 131 and 131A of the Negotiable Instruments Act, 1881 is not extended to the bills of
exchange. The reason for this is simple. Unlike cheques and bank drafts, bills of exchange are not
crossed. As bills of exchange are not crossed, there isno obligation on the part of a collecting
banker to undertake the work of collection of bills on behalf of customers. As the the collecting
banker is not charged with the responsibility of collecting bills for customers, he is not given the
statutory protection provided under the Act.

Foreign currency transactions
When we purchase f/c
f/c encashment voucher (customer side)
Form 2 (purchase f/c ) (bank side)

When we selling f/c
Form 1 (sale of f/c ) (bank side)
f/c purchase voucher (customer side)

a/c opening procdure
F:\Dhanushka\Banking\Banking - Lecture 4 - Bank
Accounts- Opening an Account.mp4
Islamic banking system
Introduction From a situation nearly 30 years ago when it was
virtually unknown,Islamic banking has expanded to become a
distinctive and fast growing segment of the international
banking and capital markets. There are well over 200 Islamic
banks operating in over 70 countries comprising most of the
Muslim world and many Western countries. Not included in
these gures are the 50 Islamic insurance (takaful) companies
operating in 22 countries, Islamic investment houses, mutual
funds, leasing companies and commodity trading companies.
Also excluded are the very largest Islamic banks engaged at a
multilateral level. To these numbers must be added the many
hundreds of small Islamic nancial institutions such as rural and
urban cooperative credit societies, Islamic welfare societies and
nancial asso- ciations operating at a local level and dealing with
rural entities, small business rms and individual households.

Many people are interested in the phenomenon of
Islamic banking and in the question of how it diers
from conventional banking, yet, despite the expansion
over the last 30 years,Islamic banking remains poorly
understood in many parts of the Muslim world and
continues to be a mystery in much of the West.

Analyses of the economic and social principles
underlying Islamic nancing,the nature of the Islamic
critique of conventional nancial systems and Islam is
not the only (or indeed the rst) religion to prohibit
usury (interest).

Islamic banking provides services to its customers
free from interest, and the giving and taking of
interest have prohibited in all transaction. Islam
bans Muslims from taking or giving interest (the
Arabic term for which is Riba), and this
prohibition makes an Islamic banking system
differ fundamentally from a conventional
banking system.
Islamic banking refers to a system of banking or
banking activity that is consistent with Islamic
law (Sharia) principles and guided by Islamic
economics.
Islamic law prohibits , the collection and payment
of interest, also commonly called Riba in Islamic
discourse.
The Importance of Islamic Banking
Modern banking, based on interest and biased in favors of
the capitalists and rich and well-to-do, is rejected as un-
Islamic because our country try to build a banking systems
with the basic and being foundation by Islam.

Islam as al-Deen is not just a religion but also a set of
beliefs, thoughts and aspects of life that creates a balanced
equilibrium between worldly (material) and spiritual
elements

Without an Islamic foundation the country will no get the
blessing from the god in the world and the hereafter.
Prepared By: Muneeb Waseem Ansari 230
Introduction of Islamic Banking
Islamic banking is interest free banking, in
which there is no fixed rate of return. Islamic
banking is the banking system which is run in
accordance with the Islamic laws and the Shari
a` board; that guides the institutions. This
Shari a` board authorizes the products that
whether these are Shari a` compliant or not.
Islamic banking is the banking that is guided by
Islamic law ( Shari a`) principles and guided by
Islamic economics. In particular, Islamic law
prohibits usury, the collection and payment of
interest,
also commonly called Riba in Islamic
discourse. Islamic banking also finds its roots
in Islamic finance and all type of transactions
are interest free and of risk sharing. The interest
is prohibited in Islamic ways of banking as it is
also obvious from Quran. In Quran, in Sura Al-
Imran, Allah said that; O you who believe! Do
not devour Riba multiplying it over and keep
your duty to Allah that you may prosper
(3:130). Same kind of prohibition regard fixed
interest is also lead in Sura Al-Rum(39) , Al-
Nisa(160-161) and Al-Baqarah(275-281) of
Quran.

Riba and Gharar are illegal under Islamic law. Riba
refers to fixed rate of interest. Gharar refers to
speculation. Islamic banking shows dramatic
improvements and developments in Pakistan.
Islamic banking is taken as national policy and it is
supported but there exist dual banking structure in
the Muslim countries. Mostly the banks of
conventional system are also opening their separate
Islamic banking divisions and branches.
The expectation of increase in growth of
networking of Islamic banking system is
increasing. The Islamic banking has increased in
terms of branches, deposits, capital funds, sources.
The ratio of income to expenses is high which
indicates increasing profitability of the sector.

Riba or Interest
Riba literally means increase, addition, expansion or
growth. It is however not every increase or growth,
which is prohibited by Islam. In shariah, Riba
technically refers to the premium that must be paid
without any consideration.
Types Of Riba
According to jurists of Islam Riba have two types.

Riba Al-Naseah
Riba Al-Fadl.

The organization of term interest dates back to 17
th

century with the emergence of banking system at
global level. Interest means giving and/or taking of
any excess amount in exchange of a loan or on debt.
Hence, it carries the same meaning/ value as that of
Riba is defend in the previous question. Further, it
is narrated that the loan draws interest is Riba.
Riba in Quran
In the Holy Quran, Allah (SWT) says in Sura Al-
Baqarah (2-279):
. And if you repent, yours is your principal
And what ever Riba you give so that it may increase
in the wealth of the people, it does not increase
with Allah. ( Sura Al-Rum 30:39)
And because of their charging Riba while they were
prohibited from it. ( Sura An-Nisa 4:161)

O you who believe! Be mindful of God and give up
what remains of al-riba if you are believers. If you do
not do so, then receive a declaration of war from God
and his Messenger. But if you repent, you shall have
your capital sums (ru`us al-amwal). You do not
deal unjustly and you are not dealt with
unjustly (2:278-279)

Riba in Hadith

"Every loan that derives a benefit (to the creditor)
is riba."
This Hadith is reported by Hazrat Ali Radi-AllahuAnhu


Abu Said al Khudri Radi-AllahuAnhu narrated
that Holy Prophet( peace be upon him) said:
Gold for gold, silver for silver, wheat for wheat,
barley for barley, dates for dates, and salt for salt, like
for like, payment made hand by hand. If anyone gives
more or asks for more, he has dealt in Riba. The
receiver and giver are equally guilty.


If the creditor received a goat as mortgage from the
debtor, the creditor may use its milk to the extent he
has spent in providing fodder to the goat. However, if
the milk is more than the price of the fodder, the
excess is riba." Usmani, para 99)
From Usamah ibn Zayd: The Prophet, peace be
on him, said: "There is no riba except in nasi'ah
[waiting]." [Bukhari, Kitab al-Buyu, Bab Bay al-
dinari bi al-dinar nasa'an, #386; also Muslim and
Musnad Ahmad]
"There is no riba in hand-to-hand [spot]
transactions." [Muslim, Kitab al-Musaqat, Bab
bay'i al-ta'ami mithlan bi mithlin; also in Nasa'i].

Difference between conventional
banking and Islamic banking
Bank Client
money
money + money (interest)
Conventional
Banking System
Bank Client Goods &
Services
money
Islamic Banking
System
Conventional Banks Islamic Banks
Money is a commodity besides medium of
exchange and store of value
Money is not a commodity thought it is
used as a medium of exchange and store
of value
Time value is the basis for charging interest on
capital
Profit on trade of goods for charging on
providing service is the basis for earning
profit
Interest is charged even in case the
organization suffers losses by using banks fund
Islamic bank operates on the basis of
profit and loss sharing
While disbursing cash finance, running finance
or working capital, no agreement for exchange
of goods & services is made.
The execution of agreements for the
exchange of goods & services is a must
while disbursing funds under Murabaha,
salam & Istisna contracts
Conventional banks use money as a commodity
which leads to inflation
Islamic banking tends to create link with
the real sector of the economic system by
using trade related activities.
Conventional banks Islamic Banks
The investor is assured of a pre determined
rate of interest
In contract it promotes risk sharing between
provider of capital (investor) and the user of
funds (entrepreneur)
Lending money and getting it back with
compounding interest is the fundamental
functions of the conventional banks
Compounding calculation is strictly prohibited
under Islamic banking system

It can charge additional money incase of
defaulters
The Islamic banks have no provision to charge
any extra money from the defaulters.
Conventional banks invest their deposit in
interest based modes
Islamic banking only deals in Halal products
and services, all transactions must be in
SHARIAH COMPLIANCE
The status of a conventional bank, in
relations to its clients, is that of creditors
and debtors.
The status of Islamic bank in relation to its
clients is that of Partners, Investors, and
Trader, Buyer and Seller.
A conventional bank has to guarantee of all
its deposits.
Islamic banks cannot guarantee of all its
deposits.
Basic Principles of Islamic
Banking
Sanctity of contracts.
Risk sharing.
No Riba / Interest.
Economic purpose / activity.
Fairness.
No valid subject matter.

Shariah / Islamic Law
Shariah lexically means a way or path. In Islam
Shariah refers to the divine guidance and laws given
by the Holy Quran, the Hadith (sayings) of the
Prophet Muhammad (peace be upon him) and
supplemented by the juristic interpretations by
Islamic Scholars. Shariah embodies all aspects of
the Islamic faith, including beliefs and practices.
Sources of Islamic Law
The Holy Quran

The Sunnah of the Holy Prophet (peace be upon
him)

Ijma ( consensus of the Ummah)

Qiyas (Analogy)
Islamic Mode of Financing
Contracts
Mudarabah
Murabaha
Musawamah
Salam
Istisna
Ijarah
Ijarah wa Iqtina ( Ijarah Muntahiyyah Bitamleek)

Sub Contracts
Wakalah
Kafalah
Rahn

Islamic Banking Fare vis--vis
Conventional Banking
The approach of Islamic banking to satisfy the
business needs of the customers is entirely
different from that of the approach adopted by
conventional banking. Basically Islamic
banking satisfies the business needs of the
entrepreneurs by the following two methods.

Profit and loss sharing modes

Debt creating modes (financing the purchase of
commodities on credit with a mark-up)
Role of Islamic banking in
Economic Development of the
Country

Islam
Aqidah
(Faith and Belief)
Shariah
(Practices and Activities)
Akhlaq
(Moralities and Ethics)
Principles Governing
While functioning within the Shariah framework, Islamic
banks an perform a crucial task of resource mobilization
and efficient allocation using either profit sharing
(Musharakah and Mudarabah) or trading & Ijarah based
categories of Islamic mode of financing. Profit sharing
modes can be used for short, medium and long-term
project, financing, import financing, pre-shipment export
financing and working capital financing transactions. In
order to ensure maximum role of Islamic finance in the
development of economy it would be necessary to create
an environment which may induce to earmark more funds
for Musharakah/Mudarabah based financing.
Small and medium enterprises (SME) sector has a great
potential for expanding production capacity and self-
employment opportunities. Enhancing the role of
financial sector in development of SME sub-sector could
mitigate the serious problems of unemployment and low
level of exports.

it can safely be said that Islamic banking has a great
potential of playing an effective role in the development
of the country.
Is Islamic Banking Viable
Islamic banking is still in the stage of evolution.
No one can disputes that there is a definite
desire amongst Muslims savers to invest their
savings in the venues which are permitted by
the Shariah. Nevertheless, they must be
provides with Halal returns on their
investments. Islamic scholars and practical
bankers took up this challenge and have made
commendable progress in the last few decades
in providing a number of such instruments.
However, the concepts of Islamic banking and
finance are still in their early stages of
development and Islamic banking is an
evolving reality for continuously testing and
refining those concepts.
Nature of Deposits in Islamic
Banks
Following are the nature of deposits in Islamic
banks.
Deposit Nature
Current Qarz
Saving Mudarabah
Qarz can be use for own need and amanah
can not be used for any purpose, thats why
Islamic banks current accounts are based on
Qarz and not in amanah.
Islamic banks offered three types of saving
accounts.

Mudarabah Saving Account
Musharakah Saving Account
Wakalah Saving Accounts
ISLAMIC BANKING AS AN
ALTERNATIVE APPROACH
One might wonder whether Islamic banking and
finance is an alternative approach to modern banking.
In fact, the banking business is no more than a
possible means to satisfy the needs of society
according to the prevailing conditions and
circumstances. Those needs should always govern the
means, not be its subject. The most important
development in modern banking is the art of
mobilizing funds for investment. It happened to be
that the method of both collecting and using of funds
was based in the West on interest paid and charged. In
contrast, Islamic banking
is a system that provides financing and attracts savings
on the basis of profit/loss sharing. One may have to
think positively of such a scheme. By waiving the
interest factor, we find an alternative vehicle to provide
financing on a different basis which should be judged
on its own merit.
For Muslims, this system of profit/loss sharing coincides
with their belief in the prohibition of interest, and helps
in mobilizing unused funds for investment and creating
new job opportunities.
As for non-Muslims, the Islamic banking system does not
contradict their faith, while it provides the society with
alternative ideas for venture capital and other tools of
investment.

Mudarabah as a contract of participation between the
provider of capital and the managing entrepreneur
responds to normal human needs. An enterprising
engineer living in the West, as an example, would
welcome any possibility that enables him to be
provided by venture capital to establish a new factory.
This could be the case with many individuals of the
same spirit. The ultimate test of such alternative is
whether it is successful or not. It can be safely said
that the idea of Islamic banking has been successful.
It is, therefore, not surprising to find several
international banking institutions started the
establishment of Islamic units or windows for some of
their customers. Islamic banking was partially
practiced by some of the Western banks and financial
institutions in Switzerland, U.K. and the United
States.
The establishment of City Islamic Investment Bank in
Bahrain is the latest example for the possible
adoption of the Islamic banking system by traditional
bankers. Economists have proven that the wider is the
freedom of
choice the higher is the level of social welfare. In
addition, wider choice implies greater respect of
human rights. When an alternative concept such as
Islamic banking is introduced, a new choice is open to
the market, with obvious economic and social
benefits. Introducing Islamic banking as a new choice
has also further benefits related to the advantages it
provides to many fund users. Commodity and service
producers would certainly appreciate equal
opportunities for obtaining capital based on the
merits of their businesses

rather than on their personal creditworthiness alone.
Those entrepreneurs who prefer to be self employed
need ways to obtain financing other than borrowing.
Islamic banking gives those pioneers such an
opportunity on the basis of profit/loss sharing. In
general, Islamic finance places more weight on the
merit
of the business to be financed, rather than the wealth
of the fund user. As a result under this new banking
alternative, a better distribution of credit may be
achieved. Therefore, I would like to recommend
strongly to the Western World that all obstacles
remaining in the way of establishing Islamic banks in
their countries be removed.

CHALLENGES AND PROSPECTS

Last but not least, I would like to conclude with a
word about the challenges facing Islamic banks and
what prospects they may have. The biggest challenge
Islamic banks have faced from their very beginning is
how to narrow the gap between the Islamic banking
model and its application; in other words, between
theory and practice. Difficulties arise in this respect
come from being relatively small in a traditional
banking environment, having to rely on bankers
trained in traditional banking, and attempting to
balance the unquenchable enthusiasm on the side of
depositors, with a limited supply of investment
opportunities.

Islamic banks have been trying hard to meet those
challenges through several means. The first is to work
for a better understanding of the concepts upon
which their operations are based. This has been a
success to the extent that now traditional bankers are
mostly cooperative and accommodating. Central
bankers have also come forward with new ideas of
better methods for supervision and control, to suit
the operations of Islamic banks. Another means is to
train their staff in this new form of banking and to
press for more banking and financial innovations
which are necessary for the new modes of finance.
Fortunately, financial engineering has come in handy
with bold and new ideas in finance which made the
Islamic model so much more applicable. Innovations
in this regard did not come exclusively from
Islamic banks. Surprisingly, financial markets
produced some useful innovations, perhaps indicating
that Islamic banking is an idea whose time has come.
Nonetheless, many challenges still remain, not the
least to the predominance of Murabaha (sale mode) in
the operations of some Islamic banks, as well as the
relative scarcity of short-term Islamic financial
instruments. The prospects of Islamic banking and
finance will depend extensively on the ability of Islamic
banks to continue facing challenges with
resourcefulness and creativity, in addition to being
worthy of trust and understanding. I believe that
competition, if allowed and maintained, not only
within Islamic banks, but also between all banks
whether Islamic or traditional, would insure a
promising future for the banking industry as a whole.

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