Module1: Overview

of Islamic Financial
System
CHAPTER 1
OVERVIEW OF THE ISLAMIC FINANCIAL SYSTEM
The development of Islamic
Introduction
Financial system is a clear
manifestation of the Islamic world
view, which is represented by the
Shariah or Islamic law as the
shariah is the bedrock of the world
view of Islam.
Function of IFS*
Four principal players in a financial
system : individuals, households,
corporations and governments.
Financial institutions including
Islamic banks, takaful companies,
and mutual funds,
**IFS –Islamic financial system
Islamic financial institution must
ensure all their transaction are
shariah compliant, not only in their
forms and legal technicalities, but
in their economics substance,
which should be premised on the
objectives outlined by the shariah,
also known as maqasid al shariah,
Firms or government agencies
raise funds in financial market via
two channels: issuing debt
securities (bonds) and equity
securities (stocks). For example, in
IFS, debt market is structured
based on Islamic debt certification
like sukuk.
Islamic economic system is based
in following philosophical
foundation:
(tawhid, rubbubiyah, risalah,
akhirah, istikhlaf, tazkiyah, kafalah,
adalah and falah)
Types of financial market :
1.Debt and Equity Market
2.Money and capital market
3. Primary and secondary market
4. Organized exchange and OTC
markets.
 CHAPTER 1
OVERVIEW OF THE ISLAMIC FINANCIAL SYSTEM cont.

Non depository institutions are There are mainly two

Types of IFI**

All financial intermidaries are

futher classified into contractual approaches to developing
generally classified into 2 broad
savings institutions (ie takaful modern islamic financial
categories which are depository
and pension fund) and instruments, namely:
institutions (ie commercial banks
investments intermidiaries (ie
and mutual savings banks) and i. The Adaptive
finance companies and
non depository institutions. ii.The innovative.
investments banks).

Muslims scholars have idetified

Requisites of the

three types of risks from the An ideal IFI is reflected through For IFI, establishing legal
Islamic Perspective: its statement if financial position framework means ensuring a
i. Essential risk (sharing risk) structure that is purly based on harmonised interface between
IFI

the PLS contracts (mudarabah the shariah Principles, which

ii. Prohibited risk (gharar) and musharakah) on both form the backbone of existing
iii. Permissible risk (operational assets and liabilities sides. legal framework.
and lidquidity risks)
**IFI –Islamic financial intermediaries
CHAPTER 2
ISLAMIC ECONOMCIS

Objectives Economics
Problems

Production Management Distribution

Decision (What to Decision (How to Decision (For
Pressing Necessities Satisfaction of produce?) produce?)
needs (hajiyyat) Whom to
(daruriyyat) produce?)

Distribution Decision Distribution

Satisfaction of
(For Whom to Decision (For Justice refers to equal
(1) Religion, (2) Embellishments
(tahsiniyyat) produce?) Whom to treatment of equals
Human Life, (3) produce?) and unequal treatment
Mind, (4) Progeny,
(5) Wealth of unequal

Free trade prevailed before the

Must be clearly distinguished
revelation of Islam and
from fixed return financing
continued to prevail thereafter The role of waqf : an
modes (murabahah &
except for the prohibition of ardent exhortation on
ijarah) predominate at the
usury, and prohibitions of trade Muslims to spend
level of Islamic Banking
malpractices through the liberally in the way of
Operations
prophet’s SAW traditions. Allah (SWT)
 FINANCIAL SYSTEM STRUCTURE OF ISLAMIC FINANCIAL SYSTEM

Financial Comprises Financial Institutions: Islamic

Markets Banks, Islamic Insurance (Takaful),
Islamic Mutual Funds etc
Direct Finance
Transaction Cost & Economic
Information
ISLAMIC FINANCIAL MARKETS

RETURNS
Lenders & FUNDS Borrowers & Excessive Gharar in financial markets arises
Savers Spenders from 3 sources:
(1) uncertainty within the financial structure
of the security,
(2) lack of key information that governs the
Indirect contract between the issuer and the
Finance holder of security,
(3) lack of important external market
The financial system Financial information about marketable securities.
consists of markets Intermediaries
and institutions
actively engaged in CHARACTERISTICS OF ISLAMIC FINANCIAL INSTRUMENTS:
the channeling of every contract is considered to be legal and lawful as
investable funds long as it does not contain any prohibited elements;
from SFUs to DFUs riba’, gharar and maysir
ISLAMIC FINANCIAL CONTRACTS/ INSTRUMENTS

Transactional Sale of Sale of right to

Contracts ownership use

Trade Equity
Financing
financing Partnership
Contracts (Murabahah) (Musyarakah)

Intermediation Free based Insurance

Partnership
Contracts service (takaful

Trust (waqaf)
Social Welfare
Contracts Gracious Loans (Qard
Hassan)
CHAPTER 3 :
MONEY AND MONETARY POLICY
Medium of exchange

Unit of account
Functions of
money
Store of value
THE CONCEPT OF

Standard of deferred
MONEY

payment

Commodity money

Types of
Metallic money
money Fiat money as
commodity
Fiat Money
Fiat money as a debt
certificate
 TIME VALUE OF MONEY
ISLAMIC PERSPECTIVE ON THE TIME VALUE OF MONEY
•The purchasing power of money keeps falling
MONEY LOSES particularly due to inflation in the economy
ITS VALUE OVER
TIME
•If one were to have money today, one can
invest the money in some business ventures and
thereby increase one’s future amount of money.
MONEY HAS
•The interest income is one of the opportunity
OPPORTUNITY cost of money, however, it is forbidden in Islam
COSTS
•Future cash flows are only expectations but due
to some circumstances, they may not happen.
UNCERTAINTY •Therefore, future cash flows are uncertain and
OF FUTURE CASH risky
FLOWS
AL-DASUQI OF THE MALIKI SCHOOL
• The seller in Murabahah should explain the deferred period that
he bought from, as it has a portion in determining the sale price
AL-KASANI OF THE HANAFI SCHOOL
• If someone buys something on deferred basis he cannot sell it
using Murabahah sale unless he clarifies the deferred period.
This is because the deferred period is ambiguously similar to the
object of the sale, although it is not actually an object of
sale…as you notice that the price increases according to the
deferred period, therefore, it has the ambiguity of being
equivalent to a part of the sale price.
AL-SHARBANI OF THE SHAFI’I SCHOOL
• His statement requires a total stipulation in determining the
extent of deferred period, as the deferred period is equivalent to
a portion of the sale price.
IBN TAYMIYYAH OF THE HANBALI SCHOOL
• If he sells it to him (buyer) with an amount for that deferred
period, then the deferred period takes a portion of the sale
price.
CHAPTER 4 :
DEVELOPMENT OF ISLAMIC FINANCIAL SYSTEM

MONETARY POLICY INSTRUMENTS

REQUIRED RESERVE RATIO DISCOUNT RATE OPEN MARKET OPERATIONS

• The required reserve ratio may be • The Islamic financial system may • In Islamic perspective, open
least objectionableas its use may reject the discount rate outright market operations may still be
reflect both monetary control as it involves charging an interest used as long as the government
and a prudential measure to rate on the loans provided by the securities traded in the
safeguard depositors’ fund Central Bank transactions are Islamic
securities.
CHAPTER 4 :
DEVELOPMENT OF ISLAMIC FINANCIAL SYSTEM
AAOIFI
IIFM
INFRSTRUCTURE FOR DEVELOPMENT
CIBAFI
IFSB
INFRASTRUCTURE
INTERNATIONAL

INSTITUTIONS

IIRA
IILM Effective Strong
Robust Greater Sound
and and
Regulatory Transparen Risk
Strong Dynami Compre
and cy and Manage
Corporate c hensive
Supervisor Disclosure ment
Governance Shariah Legal
y of Framew
Framew Infrastru
Framework Information ork
ork cture
CHAPTER 4 :
DEVELOPMENT OF ISLAMIC FINANCIAL SYSTEM

Adoption of a robust domestic

ISLAMIC FINANCIAL MARKETS

Islamic Financial System

DEVELOPMENT OF VIBRANT

Large no. of players

Efficient and active international

CHALLENGES
Islamic Financial Markets
Wide range of financial
products and instruments
Availability of a wide range of
instruments
Tax neutrality

Human resource requirements