ABMF3223

ISLAMIC
FINANCE
INTRODUCTION TO
ISLAMIC ECONOMICS & LECTURE 1
FINANCE
 INTRODUCTION
Islamic banking and finance has emerged in recent decades as one of
the most important trends in the financial world.

Islamic banking and finance is a form of banking and finance that is

based on Shariah (Islamic law).

It is common to use the term "Shariah-compliant" to describe

anything that is permissible under Shariah law.

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 INTRODUCTION
What is Islamic finance?

Islamic finance is based on the principle that provider of capital

and the user of capital should equally share the risk of business
ventures.

It encourages:
1. Sanctity of contracts
2. Engagement in business activities involving sharing of risks
and prohibition of interest
3. Prohibits speculative trading and any form of gambling.

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INTRODUCTION
The main factors distinguishes Islamic finance and conventional
finance is that all transactions are administered without involving
elements of interest or riba.

Principal objectives of the establishment of Islamic banking and

finance is to cater to the needs of Muslims in banking and finance
transactions.

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 WHY ISLAMIC FINANCE?
 Financing is vital to modern economies
 Principles and practices of conventional banking and finance
(which is based on the Western worldview) may be
inconsistent with the Islamic worldview.
 The overall objectives of IF must be in line with Maqasid al-
Shariah (Objectives of Shariah).
 Mal (wealth) is a trust; means - not an end.
 In other words, we need to have Islamic finance to address the
interest of different clients (the Muslims). However, the clients
of Islamic banking and finance products not restricted to only
Muslims.

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WHY DO MUSLIMS NEED TO BE
CONCERNED WITH ISLAMIC
FINANCE?
To comply with Shariah

Halal earnings Halal spending

Distribution of wealth

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ISLAMIC ECONOMICS
Economics: Definitions by several economists
Adam Smith: Economics or political economics is the study of
the natural world and the causes of the wealth of nations.
Alfred Marshall: Political economics or economics is the
study of the everyday lives of people, where a part of it is
about wealth, while the other part, which is most important, is
about man himself.
Milton Friedman: The science that studies the methods used
by particular societies to solve economic problems.
P. Samuelson & W. S. Nordhaus: The study of the use of
limited resources to produce valuable commodities and
distribute them to different people.

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 ISLAMIC ECONOMICS
On the other hand, the Islamic economic system has fundamentals, essence
and qualities which are distinct from systems established by the Western
economists.

Islam as complete religion has its own unique economic system. The goals of
the Islamic economic system encompasses aspects such as economic
development within the framework of Islamic values and morals, universal
brotherhood and justice, equitable distribution of wealth and individual
freedom subject to social welfare.

In contrast to conventional economic systems where regulations are subject to

man-made rules, Islamic economic system comprising rules derived from
Shariah which are sourced from the Quran, Sunnah, Ijma’ (Consensus) and
Qiyas (Inference).
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 ISLAMIC ECONOMICS
Fundamental principles of Islamic economic system are:
Social-economic justice and equitable distribution
Islam encourages business to be carried out in an honest way that
facilitates mutual benefit to the parties involved. The focus is to achieve
win/win outcomes, which leads to better economic behaviour and
performance.
Prohibition of trading of forbidden objects
Trading of haram (non-permissible) objects like pigs, alcoholic drinks,
fortune-telling are not allowed.
Trusteeship
Everything in this universe belongs to God and man is only a trustee. He
should manage every resources according to Shariah law.
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 ISLAMIC ECONOMICS SYSTEM

 Prohibition of hoarding
Islam prohibits hoarding of food, money and other basic necessities as
this practice is recognized as wasting of wealth. Islam encourages
investment in trade that in turn will generate revenue, which will be
productive for the community as a whole.

 Spirit of cooperation
Islam requires every man should give the needy a specified portion of his
wealth through zakat. Zakat is a mean of narrowing the gap between the
rich and the poor.

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 ISLAMIC ECONOMICS SYSTEM

 The duality of risk

Islam has a dual conception of risk. On one hand, it considers the
acceptance of liability (for risk) in a productive venture as legitimate for a
share in profit. On the other hand, excessive and uncontrollable risk
should be avoided as it leads to speculation.

 No gain without either effort or liability

According to Islam, money is unproductive as long as it is not combined
with labour. Savings will produce additional value only when it is invested
and the financial gain made from the investment can be shared with the
investor. The rule here is that the reward of the investor should be tied to
the result of the investment and is called “profit and loss sharing”.

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 Freedom from Freedom from
Freedom gharar qimar & maisir Freedom from
from riba dharar

Freedom to
Promote
contract
brotherhood Characteristics of
Shariah-compliant Freedom
A system banking and from price
grounded financial system control &
on morals manipulation
& ethics

Entitlement to equal, Entitlement to Promote

adequate, accurate transaction at maslahah
information fair price

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Major components of Islamic Financial System

Islamic Takaful /
Islamic
Capital Islamic
Banking
Market Insurance

Financing Equity Takaful

Deposit Islamic securities Retakaful
Investment Funds & unit trust
I-REITS
Venture capital /
Private equity
Derivatives 13

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 DEVELOPMENT OF ISLAMIC
FINANCIAL SYSTEM

Private Government People’s

initiatives directives driven

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE WORLDWIDE
Years Development
1950s • Islamic scholars and economists began presenting models of banking and
financial systems to replace banking based on interest rates.

1960s • The practice of Islamic financing principles began.

• Operations mechanisms for Islamic financial institutions were
recommended.
• Rise and fall of Mit Ghamr Savings Bank in Egypt, 1963-1967.
• Establishment of Lembaga Tabung Haji in Malaysia, 1966.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE WORLDWIDE
Years Development
1970s • Islamic banks and Islamic non-bank financial institutions were established.
• Academic institutions were set up and academic activities began to be
organised.
• Start of publication of books on Islamic banking.
• Establishment of Islamic Economic Research Centre, Jeddah.
• Establishment of Islamic Development Bank, 1975.
• Establishment of Dubai Islamic Bank, 1975.
• First International Islamic Economics Conference were held in Mecca, 1976.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE WORLDWIDE
Years Development
1980s • Government intervention in promoting Islamic banks.
• Setting up of more private sectors banks.
• A variety of Islamic banking products introduced.
• Increase in research programmes, teaching, and training.
• Increased interest among academicians and financial groups in the West in
Islamic banking.
• Conventional banks began to make available the window concept that offers
Islamic products.
• Pakistan, Sudan, Iran, Malaysia and other countries attempted to use the
Islamic banking system.
• IMF published working papers and articles on Islamic banking.
• Establishment of Fiqh Academy of OIC and other Fiqh Boards.
• Establishment of Islamic trust funds throughout the world.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE WORLDWIDE
Years Development
1990s • Growth in the Islamic window concept.
• Enhancement in asset-based financial instruments, recognition of the
importance of Islamic financial institutions and banks.
• Establishment of Islamic index at Dow Jones and the Financial Times.
• Regulations and supervision were given attention.
• Standards of AAOIFI were issued.
• Start of task of establishing support institutions.

Early • Continuous growth and maturity alongside risk challenges.

2000s • Attention on risk management and corporate control.
• Capitalisation of Islamic banks through mergers.
• Creation of asset-backed securities market.
• Islamic Financial Services Board, Malaysia formed in 2002.
• Establishment of the International Islamic Rating Body, Bahrain.

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DEVELOPMENT OF ISLAMIC BANKING

& FINANCE IN MALAYSIA
Years Development
1966 • Establishment of Lembaga Tabung Haji in Malaysia, 1966.

1970s • There were calls from individuals and groups for the government to establish
Islamic banks to cater the needs of Muslims in Malaysia.

1983 • The first Islamic bank to operate in Malaysia was Bank Islam Malaysia
Berhad (BIMB).
• BIMB offers common products and services that are available at
conventional banks except that the bank follows Shariah principles.

1984 • Establishment of the first full-fledged takaful company, Syarikat Takaful

Malaysia Berhad

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE IN MALAYSIA
Years Development
1993 • It is the long-term objective of the BNM to create an Islamic banking system
parallel to the conventional system.
• This can only be accomplished through three main components:
1. The system must have sufficient number of players
2. Products and services must cover the whole banking system
3. Inter-bank markets where operations comply with Islamic principles
must be created.

1994 • In line with the objective, BNM launched “Interest-free Banking Scheme”
where financial institutions were allowed to offer Islamic banking products
and services.
• 20 conventional financial institutions joined the scheme.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE IN MALAYSIA
Years Development
1997 • The Islamic inter-bank market was introduced, which covers 3 aspects:
1. Inter-bank trading in Islamic financial institutions
2. Islamic inter-bank investment
3. Islamic inter-bank cheque clearing system.

• BNM established the National Shariah Advisory Council on Islamic

Banking and Takaful, which advices BNM on all matters regarding Islamic
banking products and services.

1999 • Establishment of a second full-fledged Islamic bank, Bank Muamalat

Malaysia Berhad.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE IN MALAYSIA
Years Development
2002 • Establishment of the Islamic Financial Services Board (IFSB) as the
international prudential standard setting body for the Islamic finance
industry.

2004
• BNM approved the applications of 3 foreign Islamic banks to operate in
Malaysia, namely Kuwait Finance House, Al Rajhi Investment Bank, as well
as Qatar Investment Group.

2005
• The Islamic subsidiary structure to replace the Islamic bank window
institutional structure as required by the BNM.
• 7 domestic banking groups were allowed to transform their current Islamic
bank window into an Islamic subsidiary within their respective banking
groups.

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 DEVELOPMENT OF ISLAMIC BANKING
& FINANCE IN MALAYSIA
Years Development
2006 • Launching of the Malaysia International Islamic Financial Centre (MIFC).
• The MIFC is the collective efforts of BNM, Securities Commission, Labuan
Offshore Financial Services Authority, Bursa Malaysia
• The main objective of MIFC is to promote Malaysia as the major hub for
international Islamic finance through several incentives designed to create a
conducive environment for conducting Islamic finance business in Malaysia.
• BNM setup International Centre for Education in Islamic Finance (INCEIF),
a dedicated University to provide skilled and certified personnel for Islamic
Finance in Malaysia.

2009 • Establishment of Bursa Suq Al-Sila, a commodity trading platform

specifically dedicated to facilitate Islamic liquidity management and
financing by Islamic financial institutions.

2013 • Introduction of the Islamic Financial Services Act 2013 (IFSA), which
repealed the Islamic Banking Act 1983 and the Takaful Act 1984.

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