M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni: Introduction To Islamic Banking and Finance: Principles and Practice

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Introduction to Islamic Banking and Finance:

Principles and Practice

M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 1

Introduction to Islamic
Banking and Finance
Learning Objectives

Upon the completion of this chapter, the reader should be able


to:

1. Describe the conceptual basis of the modern practice of


Islamic banking and finance;
2. Explain the historical development and conceptual
arguments of Islamic banking and finance;
3. Understand the components and operating structure of the
Islamic banking and finance industry as well as the process of
development of Islamic finance products;
4. Describe the current size and worldwide spread if Islamic
banking and finance.
Learning Objective 1.1
Describe the conceptual
Basis of Islamic Banking and Finance basis of the modern
practice of Islamic banking
and finance.

• The basis of Islamic finance is Islamic law, which is also


known as the Shari’ah

• The central ruling body is the International Islamic Fiqh


Academy (IIFA)

• The underlying principles of the modern Islamic banking and


finance industry include:
○ The prohibition of interest and excessive risk
○ The permissibility of lawful sales
○ Islamic entrepreneurship
Learning Objective 1.1
Describe the conceptual
Basis of Islamic Banking and Finance basis of the modern
practice of Islamic banking
and finance.

The Shari’ah
• Defines man-to-God and man-to-man relationships

• Shari’ah is the Devine prescriptions in the form of faith and


belief, laws and moral norms broadly classified into two
strands:
– ibadah (worship and devotional practices)
– muamalat (civil transactions)

• The primary sources of the Shari’ah are the Qur’an and


Sunnah
Learning Objective 1.1
Describe the conceptual
Basis of Islamic Banking and Finance basis of the modern
practice of Islamic banking
and finance.

Figure 1.1: Shari’ah as the Basis of Islamic Banking and


Finance
Learning Objective 1.1
Describe the conceptual
Basis of Islamic Banking and Finance basis of the modern
practice of Islamic banking
and finance.

The Qur’an
• The first source of the Shari’ah
• General and specific rules on religious, commercial, political,
economic, legal and social norms
• Emphasis on mutual consent and consensus among
consenting parties
• Prohibits exploitative measures:
– Excessive risk or uncertaintly (gharar)
– Usary or interest (riba)

• Prohibits cheating and corrupt practices in the management


of funds
• Does not allow dealings in prohibited products
Learning Objective 1.1
Describe the conceptual
Basis of Islamic Banking and Finance basis of the modern
practice of Islamic banking
and finance.

The Sunnah
• The second primary source of the Shari’ah

• Comprises the sayings, practices and tacit approvals of the


Prophet Muhammad (PBUH)

• Meant to further explain the injunctions of the Qur’an

• For example, there are many prophetic traditions that deal


with riba that highlight the affirmative evidence of the
prohibition of riba already mentioned in the Qur’an
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

• The history of Islamic finance is divided into two general


aspects:

• The early days transactions

• The modern-day experiments


Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

The early days transactions

• The Era of the Prophet

• The Period of Orthodox Caliphate (632 – 661 C.E.)

• Period of the Noble Companions and the Succeeding


Generations

• The Umayyad and Abbasid Eras


Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

The Era of the Prophet


The prevailing modes of transactions during this era include:
• Shirkah (partnership) based on profit-and-loss sharing
(PLS)
• Al qard Al hasan (benevolent loan)
• Salam (Forward) contract
• Sarf (exchange of money), i.e. gold for gold and silver for
silver at the same sitting
• Ijarah (leasing)
• Trans-regional trade involved trade caravans from Mecca to
Syria and vice versa
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

The Period of Orthodox four rightly-guided Caliphs: (632 – 661 C.E.)


• Abu Bakr Assidique (632 – 634)
Failure of a segment of the Islamic state to pay the compulsory
alms known as zakat.
• Umar ibn Al-Khattab (634 – 644)
- Dramatic reforms in the economic policy of the state.
- The introduction of a centralized and permanent Bait al-mal
(the Treasury House)
• Uthman ibn Affan (644 – 656)
The introduction of the first Muslim coins
• Ali ibn Abi Talib (656 – 661)
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

Period of the Noble Companions and the Succeeding


Generations marked by:

• Building on the reforms introduced by the Prophet (PBUH)

• Tremendous increase in commercial interaction between


merchants in the Islamic state and elsewhere

• Further development of fiqh (Islamic jurisprudence)

• Advanced economic reforms based on self-exerted judgment


(ijtihad)
Learning Objective 1.2

Origins and Historical Overview of Explain the historical


development and
Islamic Banking and Finance conceptual arguments of
Islamic banking and
finance
The Umayyad and Abbasid Eras
• Issuance of the first Islamic dirham (containing the crescent, the star,
and bismillah)

• Shifting of the Treasury House to Damascus, capital


of the Umayyad, where a
bigger building was designated
as Bait al-Mal

• The Treasury House still


significant during the Abbasid
period and Mamluk era

• The dinar and dirham still


used as mediums of exchange
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

Modern-Day Experiments of Islamic Finance marked by:

• The Ottoman Empire’s fall resulting in fragmentation of


Muslim nation into different countries

• Prevalence of interest-based banking and finance system

• Lack of awareness among Muslim communities across


nations on whether to return to Islamic roots

• Experiments in Islamic finance in Egypt, Malaysia, and


Pakistan: the basis of modern Islamic banking and finance
Learning Objective 1.2

Origins and Historical Overview of Explain the historical


development and
Islamic Banking and Finance conceptual arguments of
Islamic banking and
finance
Timeline of Modern-day Experiments of
Islamic Banking and Finance from 1962 to 1975
• Initial Reforms in the Banking Industry in Pakistan in 1962

• Mit Ghamr Local Savings Bank in Egypt of 1963 (“the first modern-day
trial of Islamic baking”)

• The Malaysian Pilgrims Savings


Board, Tabung Haji of 1969
(managing savings of prospective
pilgrims by investing in Sharī’ah-
compliant investments)

• The Founding of the Islamic


Development Bank (IDB) in 1975
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

The functions of the IDB are:


• To participate in equity capital and to grant loans

• To provide financial assistance to member countries

• To establish and operate special funds for specific purposes

• To accept deposits and to mobilize financial resources


through Sharī’ah compatible modes

• To promote foreign trade, especially in capital goods, among


member countries
Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

Dubai Islamic Bank (DIB)


The first fully-fledged Islamic world commercial bank in 1975.
Operates five main business groups:

• Retail banking

• Corporate banking

• Real estate

• Investment banking

• Proprietary trading investments


Learning Objective 1.2
Explain the historical
Origins and Historical Overview of development and
conceptual arguments of
Islamic Banking and Finance Islamic banking and
finance

Timeline of Modern-day Experiments of Islamic banking and


finance from 1962 – 1975

Figure 1.2:
Timeline of
Modern-day
Experiments of
Islamic banking
and finance
from 1962 to
1975
Learning Objective 1.2
Explain the historical
Conceptual Arguments for Islamic development and
conceptual arguments of
Banking and Finance Islamic banking and
finance

The fundamentals of Islamic banking and finance business are:

• Interest-free

• Ethical

• Asset-based and asset-backed

• Partnership investment based on profit and loss sharing


(PLS) between financer and entrepreneur
Learning Objective 1.2
Explain the historical
The Development of Islamic Banking development and
conceptual arguments of
and Finance Industry Islamic banking and
finance

• Emergence of the modern Islamic banking and finance


industry in the 1960s
• Gradual expansion of the Asian markets between the 1980s
and ‘90s
• Introduction of Islamic insurance (takaful)
• Introduction of project financing with the support of the IDB
• Introduction of sukuk (Islamic bonds) and equities markets
in the 1990s
• Internationalization of Islamic banking and finance from the
early 2000s
Learning Objective 1.2
Explain the historical
The Development of Islamic Banking development and
conceptual arguments of
and Finance Industry Islamic banking and
finance

Figure 1.3: Total Global Islamic Banking Assets Growth 2012


Learning Objective 1.3
Understand the
Components of Islamic Banking and components and operating
structures of the Islamic
Finance Industry banking and finance
industry as well as the
process of development of
Islamic finance products.

The four major components of the Islamic banking and finance


industry are:

• Islamic banking

• Takaful

• Islamic capital markets

• Islamic non-bank financial institutions

These form the Islamic financial architecture and infrastructure


Learning Objective 1.3
Understand the
Components of Islamic Banking and components and operating
structures of the Islamic
Finance Industry banking and finance
industry as well as the
process of development of
Islamic finance products.
Islamic Banking

The Islamic banking component:


• Deposit-taking and finance of institutions to meet needs of
Muslim customers and investors

• May be:
- Fully fledged Islamic banks
- Islamic subsidiaries or
- ‘Windows’ of conventional banks
Learning Objective 1.3
Understand the
Components of Islamic Banking and components and operating
structures of the Islamic
Finance Industry banking and finance
industry as well as the
process of development of
Islamic finance products.
Takaful (Islamic Insurance)

• Takaful based on mutual cooperation, common welfare and


general good of society
• Development of modern takaful began with debates about
legality of conventional insurance schemes
• Controversy resolved by the Islamic Fiqh Academy in
Resolution No. 9 of 1985
• Takaful and retakaful significant in managing and mitigating
risks in Islamic banking and finance
Learning Objective 1.3
Understand the
Components of Islamic Banking and components and operating
structures of the Islamic
Finance Industry banking and finance
industry as well as the
process of development of
The Islamic Capital Markets (ICM) Islamic finance products.

• ICM is a special market where investment activities do not


contradict the principles of the Sharī‘ah

• The Islamic Capital Market is free riba, gharar and maysir

• The market players include:


- Brokerage houses
- Investment banks
- Fund management institutions
- Islamic asset management institutions
Learning Objective 1.3
Understand the
The Islamic Capital Markets (ICM) components and operating
structures of the Islamic
banking and finance
industry as well as the
process of development of
Islamic finance products.

• Various international bodies established to study, promote,


develop and set standards for Islamic finance products
include:

- International Islamic Financial Market (IIFM)

- Islamic Financial Services Board (IFSB)

- Accounting and Auditing Organization for Islamic Financial


Institutions (AAOIFI).
Learning Objective 1.3
Understand the
Components of Islamic Banking and components and operating
structures of the Islamic
Finance Industry banking and finance
industry as well as the
process of development of
Islamic finance products.
Islamic non-bank financial institutions

• Islamic financial institutions that play a facilitative role in


Islamic society ensuring economic development through non-
bank financing

• They support liquidity needs of major agents in the economy

• They include: finance companies, Islamic housing


cooperatives, Islamic microfinance institutions, waqf
management institutions, private equity /venture capital
firms, hajj and zakat management bodies
Components of Islamic Banking and
Learning Objective 1.3
Understand the
Finance Industry components and operating
structures of the Islamic
banking and finance
Islamic financial architecture and industry as well as the
process of development of
infrastructure Islamic finance products.

Crucial support for Islamic financial services:


• payment-settlement, legal institutions and framework
• safety net
• liquidity support providers
• corporate governance e.g Sharī‘ah governance structure
• standard setters for financial supervision and infrastructure
• rating and external credit assessment institutions
• financial statistics and information providers
• knowledge management/HR development institutions
• research and development institutions.
Learning Objective 1.3
Understand the
Operating Structures of Islamic components and operating
structures of the Islamic
Banking and Finance Industry banking and finance
industry as well as the
process of development of
Islamic finance products.

Key operating mechanisms of Islamic banking and finance


industry include:

• Fund mobilization

• Fund utilization

- Sharing modes
- Sale modes
- Leasing modes
Learning Objective 1.3
Understand the
Key Operating Mechanisms of components and operating
structures of the Islamic
Islamic Banking and Finance banking and finance
industry as well as the
process of development of
Islamic finance products.

Figure 1.4: Key Operating Mechanisms of Islamic


Banking and Finance
Learning Objective 1.3
Understand the
Key Operating Mechanisms of components and operating
structures of the Islamic
Islamic Banking and Finance banking and finance
industry as well as the
process of development of
Islamic finance products.
Fund mobilization
The process of raising funds to establish a viable financial
institution through the sale of shares to investors and
receiving funds from depositors. Features include:

• An ethical manner
• Net equities owned by shareholders
• Investment deposits
• Demand deposits
Learning Objective 1.3
Understand the
Key Operating Mechanisms of components and operating
structures of the Islamic
Islamic Banking and Finance banking and finance
industry as well as the
process of development of
Fund utilization Islamic finance products.

The process of using the funds realized in Sharī'ah-compliant


business:
Sharing modes - Partnership where funds initially mobilized are
invested in Sharī'ah-compliant business; parties share profits
or loss
Sale modes – The bank purchases an item on behalf the client
and resells it to them on a deferred basis or immediately
Leasing modes - The rent of an asset or hire purchase where a
rental fee is paid for a stipulated period of time mutually
agreed by the parties
Learning Objective 1.3

  Understand the
components and operating

The Development of Islamic Banking structures of the Islamic


banking and finance

Products industry as well as the


process of development of
Islamic finance products.
• Islamic banking products - financial tools through which the
financial institutions carry out business

• Designed to suit conventional market needs while retaining


the true nature of Islamic financial transactions

• Involve profitable and non-profitable dealings such as:


- zakat (alms)
- waqf (charitable endowment)
- tabaru‘at (gratuitous contracts)
Learning Objective 1.3
Understand the
The Development of Islamic components and operating
structures of the Islamic
Banking Products banking and finance
industry as well as the
process of development of
Islamic finance products.

• Islamic banking products initially based on ideas of equity


partnership or partnership modalities

• Early jurists employed ijtihad in developing Sharī‘ah-


compliant products

• Emphasis should be on developing Sharī‘ah-based


rather than Sharī‘ah-compliant financial products
Learning Objective 1.4
Describe the current size
The Growth of Islamic Banking and worldwide spread of
Islamic banking and
and Finance finance.

• Islamic banking and finance being integrated into the global


economy

• The practice of Islamic banking and finance has now been


accepted as an alternative to conventional financial systems

• Acceptance attracts new non-Muslim experts, professionals


and financial institutions
Learning Objective 1.4
Describe the current size
Islamic Banking Today: The Size of and worldwide spread of
Islamic banking and
the Industry finance.

• The industry has more than doubled in size since 2006

• Sharī‘ah-complaint assets rose by 8.85% from US$ 822


billion in 2009 to US$ 895 billion in 2010

• By end of 2011, total estimate of Sharī'ah-compliant assets


was US $1.3 trillion

• Rapid growth experienced in the Gulf Cooperation Council


(GCC) countries over the last decade

• Growth and expansion of Islamic finance industry continued


at the time of global financial crisis
Learning Objective 1.4
Describe the current size
Total Assets of Islamic Banks and worldwide spread of
Islamic banking and
in the GCC Region finance.

Figure 1.5: Total Assets of Islamic Banks in the GCC


Region
Learning Objective 1.4
Describe the current size
The World-wide Spread of Islamic and worldwide spread of
Islamic banking and
Banking finance.

• Islamic commercial banking experiencing a huge expansion


in products and areas of influence across the world.
• 2010 estimates show Islamic banks and financial institutions
number 430 across over 75 countries.
• Islamic banking spans the Middle East, North Africa, South-
East and central Asia, sub-Saharan Africa, and western
Europe.
• More than 191 leading conventional banks in Europe and
America have opened Islamic banking windows or
subsidiaries such as Standard Chartered Bank, Citibank,
HSBC, ABN AMRO, and UBS.
Learning Objective 1.4
Describe the current size
Global Coverage of Islamic Finance and worldwide spread of
Islamic banking and
finance.

Figure 1.6: Global Coverage of Islamic Finance


Learning Objective 1.4
Describe the current size
Multinational Islamic Banks and worldwide spread of
Islamic banking and
finance.

The main multinational Islamic banks are:

• Jordan Islamic Bank – 1978/1979

• Faisal Islamic Banks in Egypt and in Sudan – 1977/1978

• Kuwait Finance House - 1977

• Al Rajhi Bank - 1987

• Islamic Development Bank (IDB) - 1975


Learning Objective 1.4
Describe the current size
Future of Islamic Finance Industry and worldwide spread of
Islamic banking and
finance.

• Islamic finance set to continue significant growth path

• Legal and regulatory challenges still face the emerging


Islamic financial industry

• Islamic finance has the potential of being an alternative


mode of finance

• Islamic finance assets expected to grow consistently at 15%


per annum and exceed USD 1 trillion by 2016

• Global spread of Islamic finance products likely to soon


engulf Latin America and elsewhere
Key Terms

Bay al-salam Retakaful


Fund mobilization Riba
Fund utilization Sale modes
Gharar Sharing modes
Hajj Sukuk
Ijtihad Sunnah
Leasing modes Tabaru‘at
Maysir Takaful
Mudarabah Waqf
Qard hasan Zakat
Introduction to Islamic Banking and Finance:
Principles and Practice

M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 3

Financial Instruments of Islamic


Banking and Finance
Learning Objectives

Upon completion of this chapter, the reader should be able to:

• Describe the sources and uses of funds and the operation of


bank accounts by Islamic banks;
• Understand how exchange-based contracts are utilized as
financial instruments in Islamic finance;
• Understand how service-based contracts are utilized as
financial instruments in Islamic finance;
• Understand how partnership contracts are utilized as
financial instruments in Islamic finance; and
• Know the nature of supporting contracts in Islamic finance,
including the unilateral supporting contracts.
Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

• Sources and application of funds


is the record of the cash inflows and outflows in an Islamic
bank or financial institution over a period of time

• Dual banking system


A banking system of a
country or territory that
incorporates both the
conventional and Islamic
financial systems
Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Sources of Funds

Two major sources


1. Transaction deposits: risk-free funds which do not yield
return e.g. current accounts based on the wadi’ah concept

2. Investment deposits: profit-making but have risk of


capital loss, depending on amount invested by bank
Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Other sources
1. Current Accounts: account opened by individuals,
companies and firms by depositing cash, cheques and/or
bills (based on concept of wadi’ah)

2. Saving Account: funds deposited in saving account yield


some returns depending on bank financial results. Based on
wadi’ah, mudarabah and musharakah concepts

3. Investment Account: the most important source of funds


for Islamic banks; the customer and the bank enter into a
joint-venture agreement, based on mudarabah concept
Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Application of Funds

• Islamic banks apply funds to raise profits in different ways

• The main channels for the outflow of the funds include the:
- musharakah
- mudarabah
murabahah (cost-plus financing)
- ijarah (lease)
- istisna’ (manufacturing contract)
- bay salam
- bay mu’ajjal (deferred sale contract) models
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Exchange-based contracts in Islamic law have been


transformed into viable (debt financing) instruments:
- Murabahah (Mark-up)
-Istisna’ (Manufacture Sale)
- Salam (Forward Sale)
- Bay Dayn (Sale of Debt)
- Tawriq (Securitisation)
- Sarf (Sale of Currency)
- Tawarruq (Cash Financing)
- Bay Inah (Sale with
immediate purchase)

Debt-based financing instruments: Financial instruments


that create debt-like relationships between parties
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Murabahah (Mark-up)

• Murabahah: cost-plus financing contract where a sale is


made at a specified profit margin
• Establishes a form of mutual contract between two parties
where they agree to the mark-up
• Murabahah is derived from the root word ribh which means
profit, gain or a legal addition
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.1: A Typical Murabahah Contract


Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.2: An Overview of the Murabahah Contract


Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

The specific conditions for a valid murabahah


transaction:
1. Goods subject to murabahah
2. Original Cost Price of the Goods and any Addition
Procurement Costs
3. Margin of Profit

Margin of profit (also net margin): Ratio determining the


degree at which profit is realised, calculated by dividing net
profits by sales
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Istisna’ (Manufacturing Contract)


• Istisna’: A manufacturing contract of a made-to-order
asset based on a deferred delivery basis. It is a transaction
on a commodity before the commodity is produced
• The manufacturer is morally obliged to produce items:
- at the agreed time
- in accordance with specifications (price, quality,
description)
• The price, specification, description and quality of the
commodity to be manufactured should be fixed with the
consent of the parties to the contract
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.3: The Structure of an Istisna’ Contract


Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

The Suitability of Istisna’

The istisna’ structure is most suited for

• Project finance
• Construction
• Manufacture and design of machinery for specific purposes,
and
• Trade finance
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.4: Sukuk Transaction Using the Istisna’


Structure
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Salam or Bay al-salam (Forward Sale)

• A forward sale contract where advance payment is made for


goods to be delivered later

- does not require the commodity to exist at the time of


concluding the contract
- the delivery of the commodity is deferred

• Facilitates the commercial activities of farmers before crops


are harvested - farmers get paid in advance before a
harvest
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Salam (Forward Sale)

There are 10 conditions for the validity of a salam contract


as generally agreed upon by Muslim jurists – see page x

Bay Dayn (Sale of Debt)

• Bay al-dayn (sale of debt) A sale and purchase transaction


involving a quality debt

• Muslim jurists are not unanimous on the permissibility of


this form of sale 
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.5: An Application of Bay al-Salam as a Sharī‘ah


Financial Instrument in Modern Financial Transactions
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay Dayn Position of the Four Major Muslim Schools

• Shafi’i School: Sale of debt is allowed to a third party only


if the debt was initially guaranteed and was sold in exchange
for goods to be delivered immediately

• Hanafi School: Sale of debt not allowed in Islamic


commercial transactions

• Maliki School: Sale of debt allowed subject to conditions

• Hanbali School: divides the sale of debt into two:

- confirmed debts can be sold on the spot


- unconfirmed debts are not tradable
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay al-Inah (Sale with immediate repurchase)

• Bay al-Inah: Where a commodity is sold on a cash basis;


the seller immediately repurchases the same commodity on
a deferred payment basis at a price higher than the initial
cash price 

• Used in different real estate and house financing situations

• Bay al-inah is controversial in the global Islamic finance


industry
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay al-Inah (Sale with Immediate Repurchase)

Views on the Validity of Bay al-Inah

• The Shafi’i School: Bay al-inah contracts are permissible


in Islamic law

• The Maliki, Hanafi and Hanbali Schools: Bay al-inah is


not permissible in Islamic law because the motive of the
parties in such a contract is illegal

• The majority of jurists prohibit bay al-inah in Islamic


commercial activities because they believe it is tainted with
elements of interest
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Tawriq (Securitisation)

• Tawriq is a process of converting an asset into cash issued


as tradable certificates of investments (tradable in the
secondary market)

• Is the equivalent term for securitization in Islamic


commercial jurisprudence.

• The end product of tawriq is the issuance of sukuk or


sanadat to a large number of investors  
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Parties to Tawriq

The most important parties in securitization are:

• Originator/Issuer of Sukuk: large corporations, governments

• Special Purpose Vehicle

• Investment Banks: Islamic banks or Islamic windows of


multinational banks

• Subscribers or Investors: individuals and corporate entities


Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.6: The Flow Chart of the Securitization Process


Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Sarf (Sale of Currency)

Definition and Nature

• bay’ al-sarf: a foreign exchange contract involving


exchange of currencies either of the same or of different
kinds

• The delivery of both currencies has to be made in full at the


time of concluding the contract

• The contract of exchange must take place at the same


sitting where the contract is drawn up
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Sarf (Sale of Currency)

Validity of Foreign Exchange Contract in Islamic Law

• Trade in currency is permissible in Islamic law. “Gold for


gold, silver for silver, wheat for wheat, barley for barley,
dates for dates ... hand to hand ... ” (The Hadith)

• Limitation: the exchange must be done hand-to-hand in one


sitting if it involves different currencies

• If the currencies are the same, the currencies being


exchanged must be of equal amounts, and the exchange
must take place at the same sitting
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Tawarruq (Cash Financing or Reverse Murabahah)


• Hybrid sale contract where a customer approaches a financial
institution to purchase a commodity with payment arranged in
instalments and in turn sells the commodity to a third party for
cash
• Permissibility of Tawarruq is based on:
- The general principles of a typical contract of sale
- The absence of any bit of interest in this transaction (it does
not amount to riba)

• Permissibility of Tawarruq is subject to:


- The person must be in real need of money
- No other permissible alternative available
- The contract being free of any modicum of riba
- The customer having full possession of the commodity
Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.7:Permissible Reverse Murabahah (Tawarruq)


Learning Objective 3.3
Concept of Service-Based Contract Understand how service-
based contracts are used as
financial instruments in
Islamic finance
The service-based contracts include:

• ijarah (leasing)
• ijarah muntahia bi al-tamlik (financial lease)
• ijarah thumma al-bay (leasing and subsequent purchase)
• ujrah (fees)
• ju’alah (commission)

Ijarah (Leasing)

• Ijarah: Financing mechanism involving rental of an asset or


hire purchase where a form of rental fee is paid for a stipulated
period of time agreed by the parties
• In Islamic jurisprudence the term has been used in different
ways
Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

• Modern application of ijarah are:


- Al-ijarah thumma al-bay’ (a contract of lease ending
with sale)
- Ijarah muntahia bi al-tamlik (leasing ending with
ownership)

Ijarah Muntahia Bi al-tamlik (Financial Lease)

A typical lease contract which concludes in a transfer of legal


title and confers ownership on the lessee
- Ijarah means lease
- Tamlik denotes ownership
Learning Objective 3.3

Concept of Service-Based
Understand how service-
based contracts are used as
financial instruments in
Contract Islamic finance

Ijarah thumma al-bay (Leasing and Subsequent


Purchase)

• Ijarah thumma al-bay: a contract of lease subsequently


followed by a sale contract
• Two separate contracts are concluded under this chain
transaction
- The ijarah contract
- The purchase contract
Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance
Figure 3.8: Ijarah Thumma bay’ Contract
Learning Objective 3.3

Concept of Service-Based Contract Understand how service-


based contracts are used as
financial instruments in
Islamic finance

Ijarah mausufah fi dhimmah (Forward Lease)

• Ijarah mausufah fi dhimmah lease agreement is concluded


on a contract not in existence

• The lessor delivers the asset to the lessee in accordance


with agreed specifications

• The modern application of forward lease is diverse; it can be


used in:
- medical treatment
- education
- tourism
Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

Ujrah (Fees) 

• Ujrah: a payment for usufruct in the use of another


person’s property or payment for service in contract of
ijarah

• Most Islamic financial institutions charge service fees for


services rendered to customers. Services fees should be
paid for through the ujrah scheme

• Ujrah has been used by a number of banks for Sharī‘ah-


compliant credit card schemes
Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

Ju’alah (Commission or Reward)


• In the juristic sense, ju’alah is a one-sided contract where
reward/commission is given for accomplishment of a task

• The legality of the ju’alah contract is established in the


Qur’an and Sunnah

• There is an element of ju’alah in takaful contracts

• Ju’alah may be useful in the recovery of overdue debts


 
Learning Objective 3.3
Understand how service-
Partnership Contracts in Islamic based contracts are used as
financial instruments in
Finance Islamic finance

Concept of Equity-Based Contract


• The equity-based contracts generally involve some sort of
partnership

• Partnership contracts which have been transformed into


financial instruments are
- Mudarabah (trust financing)
- Musharakah (joint-venture partnership)
- Mmharakah mutanaqisah (diminishing partnership)
Learning Objective 3.3
Understand how service-
Partnership Contracts in Islamic based contracts are used as
financial instruments in
Finance Islamic finance

Mudarabah (Trust Financing)


• Mudarabah is a form of partnership where one party (rab
al-mal) provides the funds and the other party (mudarib)
assumes the role of the entrepreneur through effective
management

• While rab al-mal is the sleeping partner in the partnership


contract, the mudarib is directly involved in the day-to-day
running of the business

• The parties share the profit of the business venture based on


agreed percentage and bear any loss incurred
• In the event of losses the entrepreneur loses his/her labour
and the financier loses the capital
Learning Objective 3.3

Partnership Contracts in Islamic Understand how service-


based contracts are used as
Finance financial instruments in
Islamic finance

Legality of Mudarabah
The legality of mudarabah contract is established in the
Qur’an, Sunnah, practices of companions, and ijma

Types of Mudarabah
• Restricted (muqayyad)
• Unrestricted (mutlaq)

Termination of the Mudarabah Contractual Relationship


Either of the parties can terminate the contractual relationship
at any time subject to notice given to the other party within a
reasonable time prior to contract termination
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Modern application of Mudarabah

Mudarabah in Islamic banking and finance is being used in:


- venture capital
- project financing
- unit trust
- General Investment Account (GIA)
- Specific Investment Account (SIA)
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Musharakah (Partnership Contract)

• Musharakah is a word of Arabic origin meaning ‘sharing’

• It is a form of shirkat al-amwal where all partners invest


capital into the joint-venture

• Musharakah emphasises practical participation of parties in


the partnership business

• Musharakah is a form of partnership between two or more


parties based on mutual trust
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

• The return of the investors is based on actual profit of the


joint-venture

• The parties must agree at the time of initiating the contract


on the proportion of profit due to each partner

• Losses are shared in accordance with the capital investment


of each of the partners

• Musharakah is considered the most viable Islamic finance


product in modern banking
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Legality of musharakah contract

The legality of musharakah contract is established in the


Qur’an, Sunnah and the practices of the companions and
predecessors of the Prophet (PBUH).

Modern application of musharakah


Musharakah could be used effectively:
- For small and medium enterprise (SME)
- In the primary Islamic capital market (where sukuk
certificates are issued)
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Differences between Musharakah and Mudarabah


Contracts

• Sources of financing the business


• Rights of partners to participate in the management of the
business
• Sharing profits and losses
• Liability of the partners
• Ownership of assets
 
Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Musharakah Mutanaqisah (Diminishing Partnership)


... is long-term financing; a bank’s share in the ownership of a
property decreases gradually due to the continuing sale of its
shares to the customer against the payment of predetermined
instalments
• Musharakah Mutanaqisah is a chain of three contracts:
- The first contract is that of joint ownership between a
client and an enterprise (financier)

- The second contract is a contract of lease between the


financier and the client under the joint ownership
- The third contract is where the client partner concludes
another contract with the financing partner
Learning Objective 3.5
Supporting Contracts Know the nature of
supporting contracts in
Islamic finance, including
Hawalah (Transfer of Debt) the unilateral supporting
contracts.
In literal terms, hawalah means assignment, bill of
exchange, or promissory note.In the juristic sense, it is a
special type of security contract which simply means debt
assignment.
Essential Elements of Hawalah
• Muhal: The creditor/person to whom the transfer is made
• Muhil: The transferor or debtor who assigns the debt
• Muhal ‘alayhi: The transferee of the assigned debt
• Al-Muhal bihi: The transferred debt, assigned from one
debtor to another
• The debt owed by the transferee to the principal debtor
• Form of contract. The contract concludes with an offer from
the principal debtor and acceptance by transferee & creditor
Learning Objective 3.5

Supporting Contracts Know the nature of


supporting contracts in
Islamic finance, including
Figure 3.9: The Two-stage Hawalah the unilateral supporting
contracts.
Arrangement
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Modern Application of Hawalah

The modern application of hawalah comprises:


- Bills of exchange (suftajah)
- Issuance of cheques against current account
- Endorsement of a negotiable instrument
- Transfer of money or remittance (al-sarf)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Rahn (Collateral/Pledge)
A collateral, pledge or mortgage offered as security for a debt
that allows the creditor to take away the debt from such
security in the event of any default on the part of the debtor

• The legality of rahn (mortgage) contract is established in


the Qur’an and Sunnah

• The significance of rahn contract is that it is a voluntary


charitable contract (tabaru’)
• The modern application of rahn contract employed in
contracts involving credit transactions such as deferred sale
or loans from IFIs
Learning Objective 3.5
Supporting Contracts Know the nature of
supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Muqasah (Setting-off)

Muqasah: A debt settlement through a counter-


transaction or offsetting

Types of Muqasah:
1. Muqasah al-Qanuniyyah (Legal Set-off)
2. Muqasah al-Talabiyyah (Set-off on Demand)
3. Muqasah al-Ittifaqiyyah (Consensual Set-off)

Types of debt that can be set off:

• Duyun al-naqd (currency debts)


• Duyun al-‘ard (commodity debts)
• Manfa’a (usufruct)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Legality of Muqasah

Three views have been expressed:

• First view: Muqasah is an approved method of settlement


of identical debts between two parties

• Second view: Muqasah is merely an exception to bay al-


dayn (sale of debts)

• Third view: Muqasah is a sale of debts by its real nature


because its subject matter is debt which is intangible
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Kafalah (Guarantee)

Kafalah: A binding promise to be liable for the debt of a


principal debtor in case they default or fail to redeem the
debt but such liability does not relieve the principal debtor
from liability

Legality of Kafalah
The concept of guarantee has been in practice since the
time of the Prophet (PBUH)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Elements of Kafalah

• Makful ‘anhu (principal debtor or obligor or guaranteed)

• Kafil (surety or guarantor)

• Makful lahu (creditor or obligee)

• Makful bihi (object of guarantee)

• Sighah (expression)

Types of Kafalah
• kafalah bi al-nafs (physical guarantee)
• kafalah bi al-mal (financial guarantee)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.
Modern Application of Kafalah

The application of kafalah in modern Islamic financial institutions


can be seen in:

• Documentary credit system which is largely used in international


trade

• Credit card transactions  

• Supporting guarantee contract for the following major contracts


in Islamic finance: mudarabah, murabahah, ijarahi, salam,
istisna, and musharakah
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wakalah (Agency)

Wakalah Contract establishing an agency relationship between


two parties for a purpose though such authority may be
general or specific. The principal party is the muwakkil while
the agent is the wakil

The legitimacy of the concept and practice of Wakalah is


established in the Qur’an and Sunnah

Modern Application of Wakalah is seen in:


- Modern Islamic banking, finance and takaful
- Corporate Wakalah
- Wakalah model of waqf
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wadi‘ah (Safekeeping)

Wadi‘ah is a contract that entrusts one’s precious property or


money to the care of another, usually a trusted person or a
secured corporate entity i. e. the bank
• Muslim jurists unanimous in legality of wadi‘ah contract
• Wadi‘ah is used in both current accounts and savings
account
The modern types of Wadi‘ah
- Wadi‘ah yad al-amanah (Safe-keeping under a trust)
- Wadi‘ah yad al-damanah (Safe-keeping with Guarantee)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Concept of Unilateral Supporting Contract

Contracts made unilaterally without the usual offer and


acceptance at the session of contract
- Waqf (endowment)
- Ibra’ (foregoing of right)
- Hibah (gift)
- Wa’ad (promise)
- Tabarru’ (donation)
 
Learning Objective 3.5

Supporting Contracts Know the nature of


supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.
Waqf (Endowment)
Waqf: A charitable endowment in perpetuity for a specific
purpose. It assists the poor and the less privileged in the
society or benefits society at large

Ibra’ (Forgoing of Right)


Ibra’ can be defined as the waiving of one’s financial right or
ownership in totality or partially
Situations where the Islamic bank is inclined to use ibra':

- When the debtor is unable to redeem the debt


- When the customer makes an early settlement of a
debt as means to encourage such practices
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Hibah (Gift)

Hibah is the gratuitous transfer of property from one person


to another without any formal material consideration

• Hibah is used by Islamic financial institutions as a


supporting Sharī‘ah instrument in other transactions such as
al-ijarah thumma al-bay
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wa’ad (Promise)
Wa’ad: A promise or undertaking by a party to carry out a
unilateral contract

Examples of Wa'ad:
- Murabahah transactions 
- al-ijarah thumma al-bay’ contracts

Muwa’adah which is a derivative of wa’ad is a bilateral


promise in a contractual form which may be conditional or
unconditional
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Divergent Opinions of the Muslim Jurists on the Binding


Nature of Wa’ad

• Fulfilling wa’ad is recommended in financial transactions


(Shafi’i school, some Maliki jurists, and Abu Hanifah

• Fulfilling wa’ad is obligatory and it is usually enforceable


(majority of the Maliki scholars)

• Wa'ad is binding and enforceable except in cases where


it is otherwise justified (Ibn Shubrimah)
Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Tabarru’ (Donation)

• Tabarru’: a gratuitous contract/donation which is unilateral


but supportive of underlying contracts such as takaful

• Ownership in the subject matter of tabarru’ is transferred at


the time of donation from the donor to the done

• The concept of tabarru’ is applicable in takaful, as well as in


waqf donations managed by an Islamic financial institution
for the benefit of the beneficiary
Key Terms and Concepts

• Bay al-dayn
• Hawalah
• Bay al-Inah
• Hibah
• Bay al-salam
• Hilah
• Bay al-sarf
• Ibra’
• Bill of Exchange
• Ijarah
• Debt-based financing
instruments
• Ijarah mawsufah fi
dhimmah
• Dual banking system
• Ijarah muntahia bi al-tamlik
• Equity capital
• Ijarah thumma al-bay’
• General investment account
(GIA)
• Ijma
Key Terms and Concepts

• Islamic capital market • Mudarib


• Islamic finance windows • Muqasah
• Istihsan • Murabahah
• Istisna’ • Musharakah
• Ju’alah • Participation term
certificate (PTC)
• Kafalah
• Promissory note
• Legal capacity
• Rabb al-mal
• Majlis al-‘aqd
• Rahn
• Margin of profit
• Real capital
• Mudarabah
Key Terms and Concepts

• Riba • Takaful
• Secondary market • Tawarruq
• Sharī‘ah Supervisory • Tawriq
Council
• Ujrah
• Short-term liquidity
• Wa’ad
• Special investment account
• Wadi’ah
(SIA)
• Wakalah
• Special purpose vehicle
• Waqf
• Sukuk
• Tabarru’
Structure of Banking
Industry
Structure of Banks in India
Structure of Banks in India
Central Bank

•Central bank is responsible for regulating the banking


system of a nation.

•It is essentially a banker to banks as well as banker to


the Government.

•Central bank also is responsible for the monetary and


credit policies of the economy.

•Central bank issues currency notes for the country and


oversees the movement of currency value in relation to
other country’s currency value.
Reserve Bank of India

•The Reserve Bank established


of India Act, 1934
Reserve Bank as the Central
• Regulator and Supervisory authority of the monetary
bank of India.
policy of India.

• Supervises the financial system of the Indian economy.

• Issues Indian currency note (Rupee)

• Ensures stability and management of interest rate in the


economy and exchange rates in an international setting.

• Regulates and supervises the payment and


settlement systems in the economy.
Role of Reserve Bank of India

•Developing financial institutions


and markets.
• Promoting banking activities.

• Ensuring safety of depositors’ in the banking


funds system.

• Provide the supply of credit for the


currency and economy.

• Manage Government debt.

• Encourage financial inclusion in the society.

• Encourage developmental functions in the economy.


Structure of Reserve Bank of India
Commercial Banks

•Banks that accept deposits and provide loans and


advances.

•Three types of commercial banks.

• Public sector banks.

• Private sector banks.

• Foreign banks.
Structure of Public Sector Banks
Primary Functions of Commercial Banks

• Accepting deposits

• Surplus income savings are mobilized as


and and long-term deposits
short-term for specified
interest rates.
•Providing loans and
advances
• Fund needs of the society (individuals and
business establishments) are met through the
loans and advances at specified interest rates.
•Loans are long term fund assistance.
•Advances are short term fund
assistance such as cash credit, overdraft,
discounting of bills.
Secondary Functions of
Commercial Banks
• Safe custody of valuables.

• Providing foreign exchange.

• Transfer of money.

• Providing guarantee and letters of credit.

• Providing business support services such as


providing business information, credit reports etc.
Investment Banks
•Corporate financial advisory and
investment service providers.

•Assist financial markets


and provide capital
intermediation services.

•Provide consultancy, market research


and broking services to assist high net
worth individuals and other entities in
their investment goals.

•Develop ventures through project


finance to support fund needs and
export finance to meet international
Functions of Investment Banks
•Services for individuals

•Maintain financial accounts

•Provide loans, lease and


mortgages

•Pension management

•Investment management

•Private banking

•E-banking
Functions of Investment Banks

•Services for business firms and institutions

•Corporate advisory services

•Investment management of institutional


investors

•Asset management services

•Industry analysis and research

•Information provision

•Merger and amalgamation activities

•Valuation services
Development Banks and
Specialized Banks
• Specialized development financial institutions.

• Providers of long-term funds to


economic sectors experiencing shortage of
funds.

• Substantiate and bridge market gaps in developing


economies.
Illustrative Development Banks
•Industrial Development Bank of India (IDBI)

•Industrial Finance Corporation of India (IFCI).

•National Bank for Agriculture and Rural


Development (NABARD)

•Export Import Bank of India (EXIM Bank)

•National Housing Bank (NHB)

•Small Industries Development Bank of India (SIDBI)

•Infrastructure Development Finance Company (IDFC)

•Industrial Investment Bank of India (IIBI)

•State Finance Corporations (SFCs)


Co-operative Banks

•Established for the purpose of providing


funds for non- agricultural purposes.

•These banks were formed by local


communities, local geographical groups
or work groups.

•Based on the principles of cooperation


that implies mutual help, open
membership and participative
decisions.
Types of Co-operative Banks
•State Co-operative Banks.

• Apex body of co-operative banks in a state.

•Central / District Co-operative Banks.

• Established at the district level and report to the State


Co-operative Banks.
•Primary Co-operative Banks.

• Located in urban or semi-urban areas


catering to the business needs of the
locality.
• Located in rural areas to meet the funding needs of the
community / work group / area.
Structure of Co-operative Banks
Non Banking Finance Companies

•Non Banking Financial Companies offer a wide


range of services such as hire purchase
finance, lease finance and investment services.

•They provide financial intermediation and have


expanded their products profile.

•The Reserve Bank of India working group on


Financial Companies introduced registration of
such companies with net owned funds (NOF) of
Rupees 5 million or above.
Types of NBFCs

•NBFCs accepting deposits

•NBFCs not accepting deposits but rendering financial


intermediation services

•NBFCs that are investment companies (90% or more of


their total assets are in the form of investment in securities
of their group / holding / subsidiary companies)
Mutual Funds

•Mutual funds are capital market intermediaries.

•Mutual funds are established as trust entities.

•Mobilize money in the form of units


and invest them in portfolios to meet risk-
return expectations of investors.

•Mutual fund returns are shared among unit holders.


Structure of Mutual Fund
Microfinance Institutions

• Small scale financial service providers.

• Financial services are low-income


provided to households and
enterprises.
• Microfinance is provided by alternate sector such as
Non Government Organizations (NGOs), Self Help
Groups (SHGs).
Microfinance Business Models

• Joint Liability Group.

• The group who co-guarantors for other


are members of the
group.
• Linkage with Banks.

• SHGs with bank in microfinance


coordinate
activities.
Risk Management

Measurement and
management of banking
risks in a regulated
environment

•Credit risk

•Liquidity risk

•Market risk

•Operational risk
Risk Management Structure
Risk Management in Banks

•Technology driven

•Model driven

•Capital adequacy to absorb


risk

•Dynamic strategies

•Integration of risk
management process

•Risk based bank audit and


supervision

•Supportive legal
Board of Directors

• Banking
Business Risk Management Practices

• Lending Loan policy Interest rate

decision policy

Deposit Planning asset management

mobilization Internal rating systems

Asset Setting risk tolerance level

mobilization

Credit

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