49
Introduction to Islamic Banking Salman Ahmed Shaikh Research Associate, IBA www.islamiceconomics.viviti.com www.islamiceconomicsproject.wordpress.com

Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

  • Upload
    vumien

  • View
    303

  • Download
    3

Embed Size (px)

Citation preview

Page 1: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

Introduction to

Islamic Banking

Salman Ahmed Shaikh

Research Associate, IBA

www.islamiceconomics.viviti.com

www.islamiceconomicsproject.wordpress.com

Page 2: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

HISTORY OF ISLAMIC BANKING

• Islamic banking and the field of Islamic finance hasgrown appreciably since 1960.

• In Egypt, first Islamic savings bank was establishedbased on the principle of profit-sharing at Mit Ghamr in1963.

• The Islamic financial system in Malaysia was firstintroduced in 1963. Subsequently, Bank Islam MalaysiaBerhad (BIMB) commenced business on July 01, 1983.

• In 1975, the Islamic Development Bank was establishedto provide financing to projects in the member countries.

Islamic Economics Project

Page 3: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

HISTORY OF ISLAMIC BANKING

• Dubai Islamic Bank was the first modern commercialIslamic bank founded in 1975.

• Indonesia's first Islamic bank was Bank Muamalat,established in 1991.

• In Bahrain, first Islamic commercial bank wasestablished in 1978.

Islamic Economics Project

Page 4: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

OVERVIEW OF ISLAMIC BANKING

• Islamic Finance is a growing industry which is constantlyevolving and has been competitive to reach and sustainits growth momentum amidst even the Great Recessionand beyond.

• Assets of the global Islamic finance industry areestimated to grow to around $1.6 trillion by 2012(Source: Reuters).

• Some reports suggest that assets held by Islamicfinancial institutions may rise five-fold to more than $5trillion (Source: Moody’s Investor Service).

Islamic Economics Project

Page 5: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

OVERVIEW OF ISLAMIC BANKING

• According to CIMB Group Holdings, Islamic finance is thefastest-growing segment of the global financial system.

• Vatican said banks should look at the rules of Islamicfinance to restore confidence amongst their clients at atime of global economic crisis. (Source: Osservatore –official Vatican newspaper, March 04, 2009).

• Islamic Finance industry is an emerging and growingindustry. Islamic financial industry beyond banking hasachieved financial deepening in Asset Management,Investment Banking, Public Finance, Structured Financeand Insurance.

• On the geographical level too, Islamic banking has grownfrom Middle East to Europe and now is well positioned inSouth Asian markets as well.

Islamic Economics Project

Page 6: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

OVERVIEW OF ISLAMIC BANKING

• The market value of Islamic banking industry currently stands at $1 trillion.

• There are quite a few banks in the west who are workingextensively in this area to provide an alternative to theclients as the global economy goes through the financialslump.

• Few banks to mention over here are HSBC, UBS, CreditSuisse, Deutsche Bank, BNP Paribas, Citi bank, Barclays,RBS etc.

Islamic Economics Project

Page 7: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC BANKING IN PAKISTAN

• During the period of Zia ul Haq, extensive reforms werecarried out in financial system to make financialinstitutions comply with Islamic principles in theirproduct offerings.

• In February of 1980, Council of Islamic Ideologypresented a comprehensive report on the elimination ofInterest.

• Operations of specialized financial institutions likeNational Investment Trust (NIT), Investment Corporationof Pakistan (ICP), and House Building FinanceCorporation (HBFC) were transformed to comply withIslamic principles.

Islamic Economics Project

Page 8: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC BANKING IN PAKISTAN

• Banks started offering profit and loss accounts and someShariah Compliant financing schemes on a limited scale.

• Federal Shariat Court in 1991 ruled against thecompliance of the product offerings of banks with Islamicinjunctions.

• Supreme Court gave a historic verdict on interest onDecember 23, 1991 declaring all interest basedoperations to close down.

Islamic Economics Project

Page 9: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC BANKING IN PAKISTAN

• Al-Meezan Investment Bank was established in 1997,which later became Meezan Bank, as the first full fledgedIslamic commercial bank established in 2002.

• SBP Islamic Banking Department was established on15th September, 2003 with the task of promoting &developing the Shariah Compliant Islamic Banking as aparallel and compatible banking system in the country.

• Since then, Bank Islami, Dubai Islamic Bank, FirstDawood Islamic Bank, Bank Al-Barakah and EmiratesGlobal Islamic Bank have started their operations as fullfledged Islamic banks.

Islamic Economics Project

Page 10: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC BANKING IN PAKISTAN

Islamic Economics Project

Page 11: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC BANKING IN PAKISTAN

Islamic Economics Project

Page 12: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISLAMIC MODES USED IN DEPOSIT PRODUCTS

• Qard

• Wadiah

• Musharakah

• Mudarabah

Islamic Economics Project

Page 13: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

QARD

• Qard means to give anything having value to the other with thecondition that same or similar amount of that thing would be paidback on demand or at the settled time.

• It is that loan which a person gives to another as a help, charity oradvance for a certain time.

• The repayment of loan is obligatory.

Islamic Economics Project

Page 14: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

DIFFERENCE BETWEEN QARD AND AMANAH

• The repayment of Qard is obligatory even if the borrowed amountor thing is destroyed by natural calamity.

• Amanah can not be used by Ameen.

• Qard can be used for meeting expenses and investment by theborrower.

Islamic Economics Project

Page 15: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

WADIAH

• It refers to the deposited property/funds.

• An Islamic bank acts as the trustee of depositors' funds.

• It guarantees to return the deposited property on demand.

• The bank may hibah any part of benefit it received from thedeposited property.

Islamic Economics Project

Page 16: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUDARABAH

• It is a partnership in which there are two partners i.e.Rabb-ul-Maal and Mudarib.

• Rabb-ul-Maal is the investing party which contributescapital in the partnership.

• Mudarib is the working party which contributes byrendering services in the partnership.

Islamic Economics Project

Page 17: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ROLE OF RABB-UL-MAAL

• Rabb-ul-Maal is the investing party which contributescapital in the partnership.

• In case of profit, Rabb-ul-Maal shares in profit based onprofit sharing ratio agreed between the Rabb-ul-Maal andthe Mudarib.

• In case of loss, Rabb-ul-Maal bears the complete risk ofall financial losses.

Islamic Economics Project

Page 18: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ROLE OF MUDARIB

• Mudarib is the working party which contributes servicesin the partnership.

• In case of profit, Mudarib shares in profit based on profitsharing ratio agreed between the Rabb-ul-Maal and theMudarib.

• In case of loss, Mudarib loses the remuneration for hisservices.

• Mudarib is entitled to receive Ujrat-e-Misl (equivalentwage) if the loss is not caused by his willful neglect.

Islamic Economics Project

Page 19: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROFIT SHARING MECHANISM

• In Mudarabah, profit sharing ratio has to be agreed atthe start of the Mudarabah contract.

• Profit Sharing ratio does not need to be equal for bothparties.

• Profit sharing ratio in Mudarabah is not the same as losssharing ratio.

• Rabb-ul-Maal bears all the financial losses if loss occurs.

• Neither partner is allowed any fixed profit. Profit sharingratio is applied to the actual profit earned.

Islamic Economics Project

Page 20: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROFIT SHARING MECHANISM

Islamic Economics Project

Category Deposit (Rs.) Weightage Weighted Average Profit Rate

Savings 3,000 0.1 300 57 1.89%

1 Month 1,000 0.3 300 57 5.66%

3 Months 3,000 0.5 1,500 283 9.43%

6 Months 6,000 0.6 3,600 679 11.32%

1 year 7,000 0.7 4,900 924 13.21%

Total 20,000 10,600 2,000

Page 21: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUDARABAH IN LIABILITY PRODUCTS

• Mudarabah is widely used in Islamic Finance in liabilityproducts.

• Islamic banks use Mudarabah contract while offeringremunerative deposit products.

• Mudarabah is used in offering both checking and nonchecking remunerative deposits by Islamic banks.

• The accountholders (depositors) are Rabb-ul-Maal andBank acts as Mudarib.

Islamic Economics Project

Page 22: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUDARABAH IN LIABILITY PRODUCTS: CONTINUED

• Since the depositors are large and vary with respect toamount of investment and tenure of their investment,weightage mechanism is used besides profit sharingratio.

• Weightage mechanism is used to allow more profitdistribution to depositors who have kept funds for alonger tenure. This is strictly dependent upon occurrenceof profit which is not guaranteed.

• Horizontal distribution between depositors is done basedon weightage mechanism after vertical distributionbetween Mudarib and Rabb-ul-Maal (as a category) hastaken place.

Islamic Economics Project

Page 23: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUDARABAH IN ASSET PRODUCTS

• Mudarabah in Asset side products i.e. in providingfinance is rarely used by Islamic banks.

• On a limited scale, Islamic banks use Mudarabah intreasury placements.

• The reason for the rare use of Mudarabah in providingfinance is lack of documentation, lack of trust and thefact that risk of all financial loss has to be borne byRabb-ul-Maal alone.

Islamic Economics Project

Page 24: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUSHARAKAH

• It is a partnership in which partners invest as well asperform services for the firm.

• In Musharakah, there is no limitation on partners as towho can work and who can invest.

• Each partner can invest as well as work for the firm.

• It can be formed between two or more persons.

Islamic Economics Project

Page 25: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROFIT SHARING MECHANISM

• In Musharakah, profit sharing ratio has to be agreed atthe start of the Musharakah contract.

• Profit Sharing ratio does not need to be equal for allparties.

• Profit sharing ratio in Musharakah does not need to beequal to capital contribution ratio.

• It is possible that a partner with lower capital ratio isassigned a greater profit sharing ratio if it is mutuallyagreed.

Islamic Economics Project

Page 26: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROFIT SHARING MECHANISM

• No partner is allowed any fixed profit.

• Profit sharing ratio is applied to the actual profit earned.

• Incase of loss, loss is shared between partners based onlimited liability principle.

• All partners bear losses only to the extent of theirinvestment.

Islamic Economics Project

Page 27: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUSHARAKAH IN LIABILITY PRODUCTS

• Musharakah is used in Islamic Finance in liabilityproducts.

• Islamic banks use Musharakah contract while offeringremunerative deposit products.

• Musharakah can be used in offering both checking andnon checking remunerative deposits by Islamic banks.

• If bank as Mudarib also wants to invest in the investmentpool, then, a hybrid of Mudarabah and Musharakah isused.

Islamic Economics Project

Page 28: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUSHARAKAH IN ASSET PRODUCTS• Musharakah in Asset side products i.e. in providing finance

is rarely used by Islamic banks.

• On a limited scale, Islamic banks use Musharakah intreasury placements and while offering financing to bluechip companies.

• As compared with Mudarabah, bank has lesser risk inMusharakah as in case of loss, it is shared between thepartners.

• Moreover, the loss is borne by bank and the client to theextent of capital invested.

• Finally, the investment is also shared while in Mudarabah,the whole investment is provided by Rabb-ul-Maal.

Islamic Economics Project

Page 29: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MUSHARAKAH IN ASSET PRODUCTS

• The reason for the rare use of Musharakah in providingfinance is:

• Lack of documentation,

• Lack of trust and

• The fact that Bank provides bulk of the capital and isliable to incur loss to the extent of capital provided byit, which is usually higher than client’s capitalcontribution.

Islamic Economics Project

Page 30: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

MURABAHA

• Murabaha is a sale transaction. Technically, Murabaha Muajjal it

is a deferred payment sale.

• Murabaha is the most widely used alternative for short term trade

financing involving sale of an asset.

• Murabaha is used in working capital financing, SME financing

and trade financing.

• The customer is asked to buy the asset acting as an agent to the

bank because he has more knowledge about the product and

better relationships with the supplier to obtain the goods at a

competitive price and in a timely and appropriate manner.

Islamic Economics Project

Page 31: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF A MURABAHA TRANSACTIONThe process flow is as follows:

1. Islamic bank and the client sign a Master Murabaha Finance

Agreement and an agency agreement.

2. According to the agency agreement, the customer purchases

goods from the supplier on bank’s behalf.

3. The customer submits order form which the bank signs after

scrutiny and thereby give the client (its agent) the permission to

buy the asset from the supplier by submitting this signed order

form to the supplier.

Islamic Economics Project

Page 32: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF A MURABAHA TRANSACTION

4. The customer undertakes to purchase the asset from the bank.

It is a one-sided promise and undertaking.

5. The bank pays the supplier preferably directly and obtains title

and physical/constructive possession of the asset.

6. The customer in most cases obtains constructive possession for

bank on bank’s behalf at its premises.

7. Authorized person of the bank authenticates delivery at client’s

warehouse and ensure that bank’s asset remains distinct and

does not mix up with other similar asset of the client.

Islamic Economics Project

Page 33: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF A MURABAHA TRANSACTION

8. The customer signs a declaration that he has purchased the

goods on bank’s behalf and now he is willing to purchase the

asset.

9. Bank accepts the offer and the sale is executed.

10. Now, the customer is able to use or sale the asset as he

becomes the owner of the asset irrespective of the fact that he

has fully paid the bank or will do so by deferred payment.

11. The customer pays the agreed price to the bank either in

installments or in lump sum now or in future.

Islamic Economics Project

Page 34: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISSUES IN MURABAHA

• It is necessary that the client does not consume the asset before

the signing of declaration.

• It is necessary that subject matter of sale must be Halal.

• It is necessary that the client does not sale the subject matter of

sale prior to signing declaration.

• Signing Order form must always precede Declaration.

• Date on order form must be earlier than date on declaration form

when they are signed.

Islamic Economics Project

Page 35: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

APPLICATION OF IJARAH IN ISLAMIC FINANCE

• Consumer Financing

• Using Reverse Murabaha as an alternative to Credit Cards

• Corporate Financing

• Industrial Raw Material – Local and Imported

• Industrial Machinery – Local and Imported

• Plant & Equipment – Local and Imported

• Agricultural Output – Local and Imported

• Industrial Output – Local and ImportedIslamic Economics Project

Page 36: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

IJARAH

• Ijarah means to sell usufruct of an asset on rent.

• The term is also used in hiring someone to do a job or service.

• In Ijarah, right of use of a property is transferred to another

person for a consideration.

• It is an Islamic alternative for leasing a tangible asset.

Islamic Economics Project

Page 37: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

IJARAH IN ISLAMIC FINANCE

• The lease period starts when the asset has been delivered by the

lessor in a usable condition.

• The bank (Lessor) bears the ownership related costs and the

customer (Lessee) bears the usage related cost.

• Insurance, installation, import duty, delivery charges are paid by

the bank and are added in its cost and are taken into account

when quoting rentals to the customer at the time of entering into

the Ijarah agreement.

Islamic Economics Project

Page 38: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

IJARAH IN ISLAMIC FINANCE

• If the asset is destroyed or becomes unusable, the bank stops

taking rent and does not charge rent for that period.

• Penalty for late payment is charged for maintaining financial

discipline and is paid to charity.

• The asset/property remains in the ownership of the bank until the

bank sells the asset to the customer in a separate agreement.

• The client is not obliged to buy the asset at the end of the lease

period. However, in some countries, banks now take an

undertaking from the client to purchase the asset from the bank

when the lease period expires.

Islamic Economics Project

Page 39: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF AN IJARAH TRANSACTION

The process flow is as follows:

1. The customer approaches the bank for obtaining an asset on

lease.

2. The customer undertakes to make periodic lease payments for

the lease period.

3. Lease agreement and agency agreement is signed.

4. The customer as an agent to the bank buys the asset. Bank

receives the title of the asset and pays the vendor.Islamic Economics Project

Page 40: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF AN IJARAH TRANSACTION

5. The bank leases the asset and the customer starts using the

asset and pays rent for each period.

6. In the end, the customer can purchase the asset from the bank

by way of a separate purchase agreement.

Islamic Economics Project

Page 41: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

APPLICATION OF IJARAH IN ISLAMIC FINANCE• Consumer Financing

• Vehicle Financing

• Car, Motorcycle, Rickshaw, Truck etc.

• Consumer Appliance Financing

• Fridge, Refrigerator, Microwave, UPS etc.

• Corporate Financing

• Industrial Machinery – Local and Imported

• Plant & Equipment – Local and ImportedIslamic Economics Project

Page 42: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

SALAM

• Salam is a sale transaction.

• It is regarded as an exceptional sale as it does not follow all the

basic rules of Sale from Islamic point of view.

• In a Salam transaction, delivery of the subject matter is deferred.

• While payment in a Salam transaction for the subject matter is

immediate.

Islamic Economics Project

Page 43: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

SALAM

• It is used in financing goods and services that are not ready for

spot sale and will have to be delivered later.

• In Salam, payment is spot, but the delivery is deferred. It is used

in special cases to facilitate transactions.

• In Islamic Finance practice, it is used in currency trade as an

alternative for bill of exchange discounting and in agriculture

financing.

Islamic Economics Project

Page 44: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF A SALAM TRANSACTION

The process flow is as follows:

1. Islamic bank and the client sign a Salam Agreement whereby the

Islamic bank purchases certain goods from the client by paying in

full at spot.

2. Client gets the payment for the sale of subject matter which does

not exist now and will be delivered later at a specified date.

3. Islamic bank sign a parallel Salam contract with another client

and whereby the Islamic bank sells the same goods to the client.

Islamic Economics Project

Page 45: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

PROCESS FLOW OF A SALAM TRANSACTION4. The client who purchases goods in parallel Salam contract

purchases the goods from the Islamic bank by paying in full at

spot.

5. Period in Salam contract with client where Islamic bank is the

buyer is longer than the contract period of parallel Salam where

Islamic bank is the seller.

6. Islamic bank gets delivery from the client of the first Salam

contract as a buyer and delivers the goods to the client of the

parallel Salam contract.

7. Different in price in both Salam contract is the profit for the bank.Islamic Economics Project

Page 46: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISSUES IN SALAM TRANSACTION

• Salam contract can only be done of commodities whose

characteristics can be specified.

• It is necessary that the Salam contract does not involve partial

payment.

• Full immediate payment is necessary for the validity of the Salam

contract.

• Goods which are traded using Salam contract must be specified

and quantified in a manner that no ambiguity or uncertainty is left.

Islamic Economics Project

Page 47: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

ISSUES IN SALAM TRANSACTION

• It is necessary that goods sold in the Salam contract exist and

are available in the market from the date of Salam contract to

the date of delivery.

• In a parallel Salam contract, it is necessary that the client in the

parallel Salam contract must not be the same client or his

associates as in the first Salam contract.

Islamic Economics Project

Page 48: Introduction to Islamic Banking - Islamic Economics Project · HISTORY OF ISLAMIC BANKING • Islamic banking and the field of Islamic finance has ... • Islamic banks use Musharakah

APPLICATION OF SALAM IN ISLAMIC FINANCE

• Corporate Financing

• Industrial Raw Material

• Agricultural Crop Financing

• Alternate for Bill Discounting in Trade Finance

Islamic Economics Project