OVERVIEW OF

ISLAMIC BANKING
 CONTENT
2

 OVERVIEW OF FINANCIAL SYSTEM

 FINANCIAL SYSTEM STRUCTURE IN
MALAYSIA
 BANKS AS FINANCIAL INTERMEDIARIES
 ISLAMIC BANKING
 GOALS AND OBJECTIVES OF ISLAMIC
BANKING
 DIFFERENCES BETWEEN ISLAMIC
BANKING AND CONVENTIONAL BANKING
SYSTEM
 ADVANTAGES OF ISLAMIC BANKING
 FINANCIAL SYSTEM
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 Concept of Financial System

 The collection of accounting processes and
procedures that allow a business to keep
accurate financial records, monitor
accounts, prevent fraud and mistakes, and catch
any discrepancies.
 A financial system allows a company to maintain
accountability for expenditures and
revenues, and to control their finances to
minimize waste and loss.
A financial system is concerned about
money, credit and finance.
 FINANCIAL SYSTEM
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 Concept of Money
 Money is anything generally accepted as a means of
paying for goods and services and a measure of value.
 Functions of Money :
 Medium of exchange
 Measure of value
 Temporary store of value
 Concept of Credit/Loan
 An arrangement in which a lender gives money or
property to a borrower, and the borrower agrees to return
the property or repay the money, usually along with
interest, at some future point(s) in time.
 There is a predetermined time for repaying a loan, and
generally the lender has to bear the risk that the borrower
may not repay a loan (though modern capital markets
have developed many ways of managing this risk).
 FINANCIAL SYSTEM
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 Concept of Finance
 Finance is the procurement (to get, obtain) of
funds and effective (properly planned) utilization
of funds.
 It also deals with profits that adequately
compensate for the cost and risks borne by the
business.
 Finance deals with matters related to money and
the markets.
 FINANCIAL SYSTEM STRUCTURE IN
MALAYSIA
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Financial Institutions Financial Markets

a) Banking System a) Money & Foreign Exchange Markets :
 BNM • Money Market
 Banking Institutions : • Foreign Exchange Market
- Commercial banks include Islamic banks
- Finance Companies b) Capital Markets:
- Merchant Banks • Equity markets
 Others: • Bond Markets –Public Debt Securities –
- Discount Houses Private Debt Securities
- Representatives Offices of Foreign Banks
- Offshore Banks in Labuan IOFC c) Derivatives Markets:
• Commodity Futures
b) Non-Bank Financial Intermediaries : • KLSE CI Futures
• Provident & Pension Funds • KLIBOR Futures
• Insurance companies include Takaful
• Saving institutions d) Offshore Markets:
• Others: • Labuan International Offshore Financial
- Unit Trusts – Pilgrims Fund Board – Centre (IOFC)
Housing Credit Institutions – Cagamas
Berhad –Credit Guarantee Corporation –
Leasing Companies –Factoring Companies
–Venture Capital Companies.
 BANKS AS FINANCIAL
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INTERMEDIARIES
 Financial intermediaries is an entity that acts as the
middleman between two parties in a financial
transaction.
 Financial intermediaries encompass a wide range of
entities in terms of size and scale of operation
ranging from a banks, broker-dealers, investment
advisers and financial planners.
 Roles of banks as financial intermediaries:
1. Promote savings and capital accumulation to finance
projects using various modes of financing.
2. Finance international trade.
3. Mobilize resources for investments for the benefit of
society.
4. Contribute social welfare through Corporate Social
Responsibilities (CSR) and zakat.
PRINCIPLES GOVERNING OF ISLAMIC
BANKING

Islam

Aqidah Shariah Akhlak

(Faith and Belief) (Practices and (Moralities and
Activities) Ethics)

Ibadat Muamalat

Political Economic Social Activities

Activities Activities

Banking &
Financial
Activities
 ISLAMIC BANKING
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 Islamic banking is defined as banking system which

is in consonance with the spirit, ethos and value
system of Islam and governed by the principles laid
down by Islamic Shariah.
 Islamic Banking according to Islamic Banking Act
1983:
 “..acompany which carries on Islamic banking business
means banking business whose aims and operation do
not involve any element which is not approved by the
religion of Islam…”
 Islamic banking, the more general term, is based not
only to avoid interest-based transactions prohibited
in Islamic Shariah but also to avoid unethical and un-
social practices.
 In practical sense, Islamic Banking is the
transformation of conventional money lending into
transactions based on tangible assets and real
 ISLAMIC BANKING IN MALAYSIA
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 The first Islamic bank was established in

Malaysia in 1983 through Bank Islam
Malaysia Berhad.
 Later in March 1993, Bank Negara Malaysia
(BNM) introduced Interest Free Banking
Scheme (now replaced with Islamic banking
scheme (IBS).
 The scheme allowed conventional banking
institutions to offer Islamic banking products
and services using their existing
infrastructure, including staff and branches
SALIENT FEATURES OF ISLAMIC
BANKING
Ensuring
justice and
equity in
economy

Financial Main PLS are

major
transaction
concern features

Prohibition
of riba
 PHILOSOPHICAL FOUNDATIONS OF ISLAMIC
BANKING
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Tawhid
Khilafah

Amanah

Al-’adalah

Tazkiyah

Huriyyah
 GOALS AND OBJECTIVES OF ISLAMIC
BANKING
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Offer Financial Services

• The thrust is towards financing on risk- sharing and strict focus

on halal activities
• Focus on offering banking transactions adhering to Shariah
principle and avoiding conventional interest- based banking
transactions.

Economic Development

• Established a direct and close relationship between the bank’s

return on investment and the successful operation of the
business by the entrepreneur.

Optimum Resources Allocation

• Considered to be most profitable, religiously permissible and are

beneficial to the economy.
 GOALS AND OBJECTIVES OF ISLAMIC
BANKING
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Optimum Approach

• Profit- sharing principle encourages banks to go for projects with long-

term gains instead of short- term gains.
• Banks conduct proper studies before getting into projects. High returns
distributed to shareholder maximize the social benefits and bring
prosperity to the economy.

Equitable Distribution of Resources

• Ensures equitable distribution of income and resources among the

participation parties, with its profit- sharing approach which is one of a
kind.

Facilitate Stability in Money Value

• Islam recognize money as a means of exchange and not as a

commodity.
• Riba- free system leads to stability in the value of money to enable the
medium of exchange.
 PRINCIPLES OF ISLAMIC BANKING
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 Islamic banking is the conduct of banking

based on SHARIAH principle, subject to
among others:
1. Prohibition of Riba
 Riba is strictly prohibited under Islam and is
considered as haram.
 Islam allows only one kind of loan that is Qardhul
Hassan.
2. Equity participation
 Islam encourages Muslims invest their money and
become partners in order to share profits and risk in
the business instead of becoming creditors.
 In Islam, financing is based on the belief that the
financier and borrower should equally share the risks
of the business venture.
 PRINCIPLES OF ISLAMIC BANKING
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3. Prohibition of gharar
 Gharar means to undertake a venture blindly without
sufficient knowledge or to undertake excessively
transactions
 An Islamic financial system discourages hoarding and
prohibits transactions featuring extreme gharar.
4. Contractual relationship
 Depends upon the nature of transaction.
 It could be a seller and buyer relationship (Murabaha), a
lessor- lessee relationship (Ijarah), and a partnership
(Musyaraka)
5. Money as Potential Capital
 It is way of defining the value of a thing.
 Should not be allowed to give rise to more money, via
fixed interest payments, simply by being put in a bank or
when lent to someone.
 DIFFERENCES BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM
17

Islamic Banking System Characteristic Conventional Banking

•Functions and operating
modes are based on
Shariah law.
•Banks have to ensure that
all business activities are in
compliance with Shariah
requirements.
s System
Business •Functions and operating
Framework modes are based on
secular principles and not
based on any religious law
or guidelines.

•Each bank should have a Shariah •There is no such

Shariah Supervisory Board Supervisory requirement necessary.
to ensure that all business Board
activities are in line with
Shariah requirements.
COMPARISON BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM

Islamic Banking System Characteristic Conventional Banking

s
Promotes risk sharing Risk sharing Predetermined rate of
between investor and the interest
bank & the bank and the
entrepreneur : pre-agreed
proportion

Under PLS-return only if Emphasis to Credit worthiness

there is a profit product
-more concern with
soundness of the project
and managerial
competence of the
entrepreneur.
All economic agents have Moral Little attention to the moral
to work within the Islamic Dimension implications of the
moral value. activities
 COMPARISON BETWEEN ISLAMIC BANKING AND
CONVENTIONAL BANKING SYSTEM
19

Islamic Banking System Characteristic Conventional Banking

s System
•Financing is not interest – Prohibition of •Financing is interest –
oriented Riba in oriented
•Based on the principle of Financing •A fixed/floating interest is
buying and selling of assets, charged for the use of
whereby the selling price money.
include a profit margin
•Fixed from the beginning.

•Islamic banks are restricted Restrictions •There are no such

to participate in economic restrictions.
activities, which are not
Shariah-compliant.
Pay zakat as a religious Zakat Don’t pay zakat but only
obligation and tax required (Religious pay tax as required by the
by the government Tax) government
 ADVANTAGES OF ISLAMIC
20
BANKING
Justice and Fairness

• The main feature of the Islamic model is that it is based

on a profit-sharing principle, whereby the risk is shared
by the bank and the customer.
• This system of financial intermediation will contribute to
a more equitable distribution of income and wealth.

Liquidity

• Follow the profit and loss-sharing principle to mobilize

resources and are less likely to face any sudden run
on deposits.
• As such, they have a minimum need for maintaining
high liquidity.
 ADVANTAGES OF ISLAMIC
21
BANKING
Better Customer Relations

• Financing and deposits are extended under the profit and

loss sharing arrangement. The banks are likely to know their
fund users better in order to ensure that the funds are used
for productive purpose and vice-versa for investors.
• It will develops better relations between the financial
intermediary and the fund providers or consumers.

No Fixed Obligations

• Islamic banks do not have fixed obligations such as interest

payments on deposits. Therefore, they are able to allocate
resources to profitable and economically desirable activities.
• Also holds good for Islamic financing, as the payment
obligations of the entrepreneur is associated with the
revenue.
 ADVANTAGES OF ISLAMIC
22
BANKING
Transparency

• Transparent to the account holders on the investments made in

different areas and the profits realized from these investments.
The profit is then shared in the pre-agreed ratio.

Ethical and Moral Dimensions

• Strong ethical and moral dimensions of doing business and

selecting business activities to be financed, play an important
role in promoting socially desirable investments and better
individual or corporate behavior.

Banking for All

• Although based on Shariah principles to meet the financial

needs of Muslims, it is not restricted to Muslim only and is
available to non-Muslims as well.
 CHALLENGES OF ISLAMIC
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BANKING
 Misconception about Islamic banking
 Many still has a wrong understanding or
misconception against Islamic Banking which among
the thoughts are:
 Islamic Banking is only for Muslims
 Islamic Banking is not profitable because no interest is
charged
 Islamic Bank is a charitable organization
 Thus better awareness shall be create among the
customers that Islamic Banking is not only an
alternative financial approach but also in some
aspects provides better value propositions to the
consumers.
 Divergence of opinions
 Shariah interpretation versus business practicability/
 CHALLENGES OF ISLAMIC
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BANKING
 Moving towards equity based financing (Musharakah/
Mudharabah) financing?
 Commercial banks requires a new set of technical and risk
management capabilities i.e. industry experts and know-how
 Market readiness – profit sharing, trade secrets, bank as strategic
business partners (potential conflicting interest).
 Balance sheet size, risk appetite and underwriting capabilities
 Supervisory and prudential regulatory framework.
 Accounting and auditing standards.
 War of talents
 Global shortage of Islamic finance talents at almost all levels
 Inadequate pool of Shariah scholars with the right combination of
knowledge in Shariah and modern finance
 Rising Cost for Small Islamic Banks
 Ballooning operating costs for Islamic banks as opposed to relative
cost stability for the overall banking system - expenditure on IT
infrastructure, expenses for R&D and product innovation and network
expansion and new delivery channels
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