Islamic Banking Theory and Practice

Course code MBF 706

Instructor
Dr. Muhammad Azhar Khan

1. Characteristics of Islamic
Financial System
1. Allah is the Sustainer
2. God is Real Owner of Everything and Man is Merely
a Trustee
3. Everything Created for Service and Use of Man
4. Concept of Halal and Haram
5. System of Sadaqat and Zakat
6. Prohibition of Interest
7. Ban on Hoarding of Wealth
8. Policy of Moderation
9. Condemnation of Monasticism and Materialism
10.Equity and not Equality

2. Principles of Islamic Financial System

Basic idea of Islamic Financial System

is prohibition of receipt and payment
of interest. Literature based on the
divine guidance about Islamic financial
system suggest the following
principles.
1. Money as potential capital
2. Prohibition of Interest
3. Risk Sharing
4. Sanctity of Contracts

2. Principles of Islamic Financial System

5. Sharia Approved Activities

6. Individual Liberty
7. Right to Own Property
8. Economic Inequality and Charity
9. Social Equality
10. Circulation of Wealth

3. The existing economic

system
Some of the known economic systems
are;
Capitalism
Socialism
Communism
Islamic economic system

4. Comparison of the Economic

Systems
1. characteristics of Socialism and communism,

such as their definition, ideas, economic

system, social structure, freedom of choice,
ownership of private property, and means of
control etc.
2. A comparison of the major economic systems in

the world, i.e. Capitalism, Socialism,

Communism, and Islamic economic system.

5. Money in Islamic Financial

System
Concept of money, how it evolved from

representative money to fiat money.

Role of money in the economy and its

usage as a tool to create debt.

You will also watch an animated

documentary explaining the role of money

as debt.

5. Money in Islamic Financial

System
Implication of Fiat Money
Credit Creation
Inflation
Unjust wealth appropriation
Deposit multiplication

6. Factors of Production in
Islamic Economic System
Conventional concept of factors of

production, i.e. land, labor, capital, and

entrepreneur.
Concept of factors of production in Islamic

economic system.
Role of money as of being a factor of

production.

6. Factors of Production in
Islamic Framework
All productive inputs are grouped into two
categories;
1. Factor inputs: those inputs that dont get

consumed in the production process.

2. Consumed inputs: those inputs that are

consumed during the production process and

lose their original nature and shape, e.g. fuel,
raw cotton, plastic, etc.

6. Factors of Production in
Islamic Framework
Money as factor of production:
Money is recognized as consumed input
and become useful only when converted
into consumed input or factor input.
Money itself is not considered a factor of
production but it has the potential to
become a factor of production.

7. Money: An Islamic
Viewpoint
The Concept and Nature of Money in Conventional
system :
1. Money is a commodity and is used to obtain
other goods.
2. Widely Marketable as it is highly in demand and
valued good. Thus, it is sure that it can be used
anytime and anywhere.
3. It can be transport easily. Money is made to
make human life easier therefore to make sure
that convenience is important.

7. Money: An Islamic
Viewpoint
Nature of money under Conventional system
5. Money is relatively imperishable. It is durable and
can be used for future purchases.
6. Easy to store.
7. Easily divisible
8. Money lasts forever.
9. All units of money are similar, means that it is easy
to distinguish and estimate the value of the money.

7. Money: An Islamic
Viewpoint

Nature of money under Islamic system

1. Islam treats money as unit of account to determine

the relative worth of goods and services.

2. A medium of exchange, and not a store of value.
3. All units of money of the same denomination are

100% equal to each other.

4. It becomes useful only when it is exchanged into a

real asset or used to buy services.

5. Money cannot be sold or bought on credit.

8. Principles of Islamic Banking

Governing features of Islamic banking system
1. The prohibition of interest based
transactions
2. Avoidance of speculations (gharar)
3. Avoidance of oppression (zulm)
4. Introduction of Islamic tax (zakat)
5. Financing of Sharia Approved activities
. Comparison of Islamic and conventional banking
system.

9. Islamic Modes of Financing:

Murabaha
After this lecture you should be able to understand
The concept of Murabaha
The stages involved in Murabaha transaction
Practical issues in Murabaha and their resolution
Murabaha documentation
Uses of Murabaha as Mode of finance (Local as
well as import Murabaha)

10. Islamic Modes of Financing:

Salam and Istisna
1. Salam and parallel Salam
2. Istisna and parallel Istisna
3. And the differences between the Salam
and Istisna modes of financing

11. Islamic Modes of Financing:

Musharakah
Musharakah is a form of partnership which is based
on profit and loss sharing.
Types of Shirkah
a. Shirkah al-Aqad (commercial partnership)
b. Shirkah al-Milk (joint-ownership).
Shirkat al-Aqad refers to partnership with
commercial objective, whereas, Shirkah al-Milk
refers to joint-ownership in a particular asset.

12. Islamic Modes of Financing:

Mudarabah
This is a kind of partnership between the two
parties where one partner contributes capital and
the other one contributes efforts as manager or
entrepreneur. The profit of the venture is share at
an agreed ratio while the losses are borne by the
capital provider.
The investment comes from Rabb-ul-Maal
(Investor) while the management and work is an
exclusive responsibility of the working partner,

13. Islamic Modes of Financing:

Diminishing Musharakah
The concept of Diminishing Musharakah
Features and rules of diminishing Musharakah.
Uses of diminishing Musharakah particularly in
House Financing for four purposes:
1. Purchase of House
2. Construction of House
3. Renovation of House
4. Balance Transfer Facility (BTF)

14. Islamic Modes of Financing:

Ijarah
Ijarah literally means to rent or lease something. In its technical
sense, the term Ijarah has two different connotations as follows:
I. A hire contract to employ the services of a person with

wages given to him/her as a consideration for his/her hired

services.
II. A lease contract to transfer the usufruct of a particular

property to another person in exchange for a rent from the

client.

15. Applications of Islamic Financing

The concept of Islamic financing regarding its
applications in different areas like. Musharakah,
Mudarabah, and Murabaha is applied in;
1. Project financing
2. Working capital financing
3. Import financing
4. Export financing

16. Islamic Investment

Funds
Principles of Islamic investment funds.
Modes of investment of funds and their
management under Islamic financial system.
1. Equity fund
2. Ijarah funds
3. Commodity funds
4. Murabaha funds
5. Bai al Dain
6. Mixed funds

17. Sukuk
Sukuk is the Arabic name for a financial certificate.
Its an Islamic alternative to the conventional
interest bearing bonds.
Sukuk is a Trust certificate in which investor
returns are derived from legal or beneficial
ownership of assets.
Comparison of Sukuk and Bond
Controversies/objections in Sukuk

18. Risk Underlying Islamic Financial

Modes
After this lecture you will be able to understand
The basic concept of risk and its classification
into different types.
Risks faced by the financial institutions.
Uniqueness of risk in Islamic banks.
Risks in Islamic Financial instruments.
How to mitigate in Islamic financial
instruments.

19. Takaful (Islamic Insurance)

Concept of conventional Insurance
Objections against conventional
Insurance system
Difference between Takaful and
conventional insurance
Different models of Takaful like
Wakalah model, Mudarabah model,
and the Hybrid model (Wakalah and
Mudarabah)

20. Evolution of Islamic Banking in

Pakistan
Social and political background of
Pakistan
History of Islamic banking in Pakistan
Fact and figures regarding Islamic
banking in Pakistan

Summary of the Lecture

In this lecture we had an introduction
of the course.