ISLAMIC BANKING:

Islamic banking is banking or banking activity that is consistent with the principles of
sharia (Islamic law) and its practical application through the development of
Islamic economics. As such, a more correct term for Islamic banking is sharia compliant
finance.

Sharia prohibits acceptance of specific interest or fees for loans of money (known
as riba, orusury), whether the payment is fixed or floating. Investment in businesses
that provide goods or services considered contrary to Islamic principles (e.g. pork or
alcohol) is also haraam ("sinful and prohibited"). Although these prohibitions have been
appli. ed historically in varying degrees in Muslim countries/communities to prevent un-
Islamic practices, only in the late 20th century were a number of Islamic banks formed
to apply these principles to private or semi-private commercial institutions within the
Muslim community.

PRODUCTS AND PRINCIPLES THAT ARE FOLLOWED IN ISLAMIC BANKS IN

BANGLADESH:

Traditionally, banks accept deposits and offer loans. Therefore, banks normally have
both deposits and loan products. For Islamic banks there is no room for offering loan
products except Qurd-al-Hasana or interest-free loan. Therefore, for Islamic banks
asset-side products are known as investment products. These investment products
resemble to loan products in conventional sense, although Islamic banks invest money
through various unique principles and techniques which are interest-free and shariah-
complaint.

The major part of the deposits of Islamic banks in the country is mobilized on the
principles of Al-Wadia (safe custodianship) and mudaraba (trust financing). Based on
these two principles Islamic banks offer various types of deposits accounts which are:
Current accounts, savings accounts and investment accounts. According to Bangladesh
Bank, as of September 2014, among different types of deposits of the Islamic Banking
industry, Mudaraba Term Deposits secured the highest position (49 per cent) [chart-1]
followed by Mudaraba Savings Deposits (MSD) (17 per cent), Mudaraba Special Savings
(pension/profit) Deposits (9 per cent), Special Scheme Deposit (10 per cent), Current
deposit.

Based on the theoretical viewpoint and nature of the contracts, the Islamic
investment principles can primarily be classified into two broad categories: profit and
loss share (PLS)-based contracts and non-PLS based contracts. The non-PLS based
contracts or debt-like instruments are usually used by Islamic banks as Islamic mode of
financing. These contracts are mainly five sale-based contracts which are: Salam Sale,
Muajjal Sale, Istisna Sale, Ijarah Sale, Murabaha-Sale.

In practice, Islamic banks offer various fee-based products based on these five-
principles. Therefore, the shariah principles adopted by Islamic banks are:

a) Profit and loss sharing,

b) fees-based
c) free services and
d) ancillary principles.

Mudarabah (capital or trust financing) and musharakah (partnership), are the only two
principles that fall into PLS-based contracts. Currently, PLS-based products are not very
popular and is very negligible in terms of size. As of September 2014, the total share of
Musharaka (1.20 per cent) and Mudaraba (0.05 per cent) is only 1.20 per cent and 0.05
per cent respectively.

Fees-based principles can be further divided into three categories:

i) fees-based on mark-up, ii) fees-based on commission and iii) Fees-based on

services. Products and services which charge fees-based on mark-up usually use
Muajjal Sale, Ijarah Sale, Murabaha-Sale and Hire Purchase.

Two are pre-dominant in the financing principles of Islamic banking: Murabahah (Cost-
plus-profit margin) and Ijarah (Lease financing). The analysis of mode-wise investment
as of September 2014 revealed that the highest investments was made through Bai-
Murabaha mode (44.01 per cent) at the end of the quarter July-September 2014,
[chart-2] followed by Bai-Muajjal (24.94 per cent), HPSM (15.73 per cent), Ijara &
Ijara-bil-Bai (7.48 per cent), others (4.48 per cent). Fees based on commission
principles are used normally for different types of LC’s, Bank Guarantee and various bill
collection. Fees based on services principles are used for foreign remittance
disbursement, locker services, issuing PO, DD, ATM cards and internet banking, etc.,
within free service principles, banks offer qard al hasana. For letter of credit (LC)
facilities, banks in the country normally use murabaha and wakalah principles in
addition to Musharakh principles.

Islamic Shariah based Commercial Banks

1. Al-Arafah Islami Bank Limited

2. EXIM Bank Limited

3. First Security Islami Bank Limited

4. ICB Islamic Bank Limited

5. Islami Bank Bangladesh Limited

6. Shahjalal Islami Bank Limited

7. Social Islami Bank Limited

8. Union Bank Limited

ADVANTAGES OF ISLAMIC BANKING

Some of the major advantages of Islamic banking:

Justice and Fairness:

The main feature of the Islamic model is that it is based on a profit-sharing

principle, whereby the risk is shared by the bank and the customer. This system
of financial intermediation will contribute to a more equitable distribution of
income and wealth.
Liquidity:

Follow the profit and loss-sharing principle to mobilise resources and are less likely to
face any sudden run on deposits. As such, they have a minimum need for maintaining
high liquidity.

Better Customer Relations:

Financing and deposits are extended under the profit and loss sharing
arrangement. The banks are likely to know their fund users better in order to
ensure that the funds are used for productive purposes and vice-versa for
investors. In this way, it develops better relations between the financial
intermediary and the fund providers or consumers. It will also promote
productive economic activities and socio-economic justice.

No Fixed Obligations:

Islamic banks do not have fixed obligations such as interest payments on

deposits. Therefore, they are able to allocate resources to profitable and
economically desirable activities. This also holds good for Islamic financing, as
the payment obligations of the entrepreneur is associated with the revenue.

Transparency:

Transparent to the account holders on the investments made in different areas

and the profits realized from these investments. The profit is then shared in the
pre-agreed ratio.

Ethical and Moral Dimensions:

Their strong ethical and moral dimensions of doing business and selecting
business activities to be financed, play an important role in promoting socially
desirable investments and better individual/corporate behavior.

Destabilizing Speculation:

Most of the non-Islamic institutions are trading heavily into financial markets and
carrying out huge speculative transactions. These transactions are sources of
instability and the returns on investments are highly speculative. On the
contrary, Islamic banks are prohibited from carrying out such activities. This
destabilizes the speculation and is in the better interest of the depositors.
8 Banking for All:

Although based on Syariah principles to meet the financial needs of Muslims, it is

not restricted to Muslims only and is available to non-Muslims as well.

SHORTCOMINGS OF THE SYSTEM

 While competing with conventional banks, the PLS basis of Islamic

banking makes the proposal unattractive to deposit holders under
Modarabah.

 Banks have to recruit highly competent persons in evaluating each

proposal or project before entering into any partnership. Any collusion
between entrepreneurs and experts will affect deposit holders.

 Financial fraudulent practices will help in manipulating profit figures on

lower side to reduce the share of the bank/shareholder in the profit of
the business.

 Gestation period of three to five years in generating profits from the

business will discourage deposit holders in blocking funds in
Modarabah accounts. As a result, only trading community and that too
in big towns will enjoy the benefits of such facility. Small units will be
worst sufferers. The claim of faster economic growth may not
therefore be sustainable for a long time. Also due to uncertainty of
weather God, financing to agricultural activities would not be profitable
and as such this activity will remain outside the Islamic banking
system.

 Short term financing is a dominant factor in Islamic banking system.

As such long term financing will have to be provided by the
government itself or by the conventional banking system.

 Most profitable enterprises would like to part with a fixed percent of

interest than parting with higher profits under PLS scheme.
Assignment no-05

Assignment on
Islamic Banking

Submitted to
Md. Alamgir Hossen
Assistant Professor
IBA-JU

Prepared by
Md. Sabbir Hossain
ID:201501059
WMBA Program
IBA-JU

Date of Submission:

11th November, 2016