Islamic Banking Notes

Capitalist Economic System Islamic Economic System
It is an interest-based economy It is a Shariah based economy

It believes in private ownership of Islam has a unique concept of
factors of production based on private ownership by which Allah has real
profit ownership over everything
This economy believes in primary This economy believes in primary and
rights to property which are people secondary rights to property,
who have contribution in factors of secondary rights are Zakat and Sadqa
production. given to underprivileged persons
In Capitalism, individuals have liberty In Islam, freedom is bound by Shariah
to no extent, meaning they can laws, meaning individuals can only
involve in immoral activities such as engage in Halal economic activities
smuggling
Distribution of resources rely on Distribution of economy rely on rules
market mechanisms of Holy Quran
Conventional Banking Islamic Banking

Conventional banks use money as a Islamic banks create links with trade
commodity which leads to inflation. It related activities which contributes to
is a money lending business economic growth. It is a product-
based business.
These banks make profit by charging Profit on trade of goods or charging on
interest on products and adding mark providing service is the basis for
ups earning profit.
Profit and loss are shared on basis of Profit is shared on per agreement
agreement between the parties between parties and investor bears all
involved. These banks cannot bear the loss. These banks can bear loss
loss
They treat money as commodity and They treat money as mode of
thus sell money on interest exchange and thus cannot sell money
on interest
Relationship is often defined as Relationship is defined as partners or
creditor and debtor investors
Modes of Financing in Islamic Banking:
Mudarabah: Mudarabah is a partnership where one party invests capital (Rab Ul

Maal) and the other party renders services (Mudarib) in a joint business. It is a
partnership where the returns are shared between the bank and client as per
the agreed profit-sharing ratio whereas, the investor bears all the loss.
*Bank is the sleeping partner (Rab Ul Maal) and the client is working partner
(Mudarib). It is for business purpose.
Musharakah: Musharakah means “sharing”, which is a partnership where all the
partners invest capital in a joint business and become owners of the business
with their ratio of investment. They share profits as per agreed profit-sharing
ration and share loss as per investment ratios. Unlike Mudarbah, in which only
the Mudarib can work, in Musharakah any partner can invest or work.
*It is for business purpose.
Diminishing Musharakah: Mostly used in home financing, in which client and
bank purchase the products jointly. Some ownership is of client which is equity
and some ownership is of bank which is debt. The client purchases full
ownership by paying rent on monthly/gradually to the bank on agreed upon
debt-to-equity ratio. Each month rent paid is decreased as bank ownership is
now decreasing and is transferring to the client.
*It is for product financing purpose.
Murabahah: Murabaha refers to an Islamic way of banking where the lender and
borrower sign a sales contract where client buys goods from a supplier for his
purpose and the goods come under the constructive possession of the bank. Any
loss will bear by bank. The bank sells the asset to the borrower after adding its
profit. The borrower can then either pay the full amount of the asset to the bank
or pay in monthly installments in form of deferred payments.
*It is for sales contract financing purpose.
Ijarah: Ijarah is an Arabic word and it means “to give something on rent”. Under
the concept of Ijarah in Islamic banking, a customer can use an asset or
equipment, which is owned by an Islamic bank, for a fixed period against a fixed
price. The bank recovers cost with profit in form of rent from the client. The bank
transfers ownership to the client of the equipment by giving the said equipment
on nominal price to the client.
*Any late payment fee obtained from the client is given to charity according to
SBP charity policy. Ijarah is used for personal and commercial finance.
Salam: It is a sales contract where full payment in discounted price is made in
advance to the client for working capital needs and goods delivery is set on a
future date, when client makes profit on selling the finished goods and repays
the bank. It is mostly used in agricultural financing.

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Islamic Banking Notes

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Capitalist Economic System Islamic Economic System

It is an interest-based economy It is a Shariah based economy

Conventional Banking Islamic Banking

Mudarabah: Mudarabah is a partnership where one party invests capital (Rab Ul

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