Case Studies in Islamic Banking and Finance: Case Questions & Answers
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For example, 'A' tells 'B' on 1st January that he will sell his car on 1st February to 'B', the sale is void because it is attributed to a future date. The subject matter should be a property having value. Thus goods having no value cannot be sold or purchased. The subject matter of sale should not be a thing used for an un-Islamic purpose.
The subject matter of sale must be specifically known and identified to the buyer. For Example, 'A' owner of an apartment says to 'B' that he will sell an apartment to 'B'. Now the sale is void because the apartment to be sold is not specifically mentioned or identified to the buyer. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance.
The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of trade. Answer: Murabaha is typically used to facilitate the short-term financing requirements of the customer. The following are the uses of Murabaha: 1. Purchase of raw material, goods and merchandise of all kinds and description 2. Purchase of equipments 3.
Import of goods and merchandise 4. Export financing pre-shipment 5. Answer: Bai' Muajjal is the Arabic equivalent of "sale on deferred payment basis". The deferred payment becomes a debt payable by the buyer in lump sum or in installments as may be agreed between the two parties. In Bai' Muajjal, all those items can be sold on deferred payment basis which come under the definition of tangible goods where quality does not make a difference but the intrinsic value does.
Those assets do not come under definition of capital where quality can be compensated for by the price and Shariah scholars have an 'ijmah' consensus that demanding a high price in deferred payment in such a case is permissible. The price to be paid must be agreed and fixed at the time of the deal. It may include any amount of profit agreed between the parties.
Once the price is fixed, it cannot be decreased in case of earlier payment nor can it be increased in case of default. In order to secure the payment of price, the seller may ask the buyer to furnish a security either in the form of mortgage or in the form of any other item. If the commodity is sold on installments, the seller may put a condition on the buyer that if he fails to pay any installment on its due date, the remaining installments will become due immediately. Answer: Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former.
Thus, it is different from Murabaha in respect of pricing formula. Both the parties negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell. Answer: Ijarah refers to transferring the usufruct of an asset but not its ownership.
Under Islamic banking, the bank transfers the usufruct to another person for an agreed period at an agreed consideration. The asset under Ijarah should be valuable, non-perishable, non-consumable identified and quantified. All those things which do not maintain their corpus during their use cannot become the subject matter of Ijarah, for instance money, wheet etc. The bank acquires that asset as per undertaking of the customer to acquire the said asset on Ijarah basis. The bank leases transfers the use of the asset it to the customer for an agreed period of time and against an agreed amount of rentals.
An Ijarah agreement, signed between the bank and the customer, stipulates all the relevant conditions with regard to the transaction. According to this agreement the bank is Lessor and the customer is Lessee. During the Ijarah period, the corpus of the leased property remains in the ownership of the bank and only its usufruct is transferred to the lessee. The following main points are considered in the Ijarah transaction: 1. As the corpus of the leased asset remains in the ownership of the Islamic bank, all the liabilities emerging from the ownership shall be borne by the bank.
It is necessary for a valid lease that the leased asset is fully identified by the parties. The lessee customer cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. However, if no such purpose is specified in the agreement, the lessee can use it for whatever legitimate purpose it is used in the normal course.
The lessee is liable to compensate the lessor bank for any harm to the leased asset caused by any misuse or willful negligence. The leased asset shall remain in the risk of the bank throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor. A property jointly owned by two or more persons can be leased out and the rental shall be distributed between all joint owners according to the proportion of their respective shares in the property. A joint owner of a property can lease his proportionate share only to his co-sharer and not to any other person.
The rental must be determined at the time of contract for the whole period of lease. It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of executing a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid.
The determination of rental with regard to the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shariah, if both parties agree to it, provided that all other conditions of a valid lease prescribed by the Shariah are fully adhered to. The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
The lease period shall commence from the date on which the leased asset has been delivered to the lessee. If the leased asset has totally lost the function for which it was leased, the contract will stand terminated. The rentals can be used on or benchmarked with some Index as well. In this case the ceiling and floor rentals would specifically be mentioned in the agreement for validity of lease.
At the end of the lease period, the ownership of the property may be transferred to the lessee against a nominal price through a separate sale deed to be executed after the expiry of the lease. Answer: There are several key differences between conventional mortgage finance and Islamic mortgage finance. Under conventional mortgage, in order to purchase a property the customer borrows money and repays it with an additional amount over a period of time.
The additional amount is the amount of interest which is against the Shariah rulings of Islam. Under Islamic mortgage finance facility, Islamic bank shares with the customer in purchasing his desired property. Accordingly, the customer and the bank become the joint owners of the property in proportion to their share in purchasing the property. Over a period of time, the customer manages to purchase the entire share of bank in the property. Ultimately, the customer becomes the sole owner. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.
Answer: The difference between an interest based financing and a valid lease does not lie in the amount to be paid to the lessor. If the asset is destroyed during the lease period, the lessor will suffer the loss. Similarly, if the leased asset looses its usufruct without any misuse or negligence on the part of the lessee, the lessor cannot claim the rent, while in the case of an interest-based financing, the financier is entitled to receive interest, even if the debtor did not at all benefit from the money borrowed.
So far as this basic difference is maintained, i. Therefore, the use of the rate of interest merely as a benchmark does not render the Ijara contract invalid as an interest-based transaction. It is, however, advisable at all times to avoid using interest even as a benchmark so that an Islamic transaction is totally distinguished from an un-Islamic one, having no resemblance of interest whatsoever.
Answer: It is one of the basic requirements of Shariah that the parties to the contract must exactly know its considerations. Under Ijarah agreement, amount of rent is one of the prime considerations of the agreement. So far as the parties are agreed with mutual consent upon a well-defined benchmark which would serve as a criterion for determining the rent, and whatever amount is determined, based on such benchmark, will be acceptable to both parties, therefore, there should not be any dispute.
However, in order to save the parties from unforeseen losses due to the either way movement in the interest rate, the scholars have advised that there should be a floor and cap for the amount of rentals stipulated in the contract in case variable benchmarks is taken to determine the rental amount. Answer: It is allowed in Shariah that the lessor signs a separate promise, but not an agreement or contract to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent.
There can also be a unilateral promise by the lessee to purchase the asset at the end of the Ijarah period. Alternatively, there may be an undertaking by the bank to sell the asset to the lessee at the end of the Ijarah period. However, Ijarah agreement should not be dependent either on the promise by the lessee to purchase or the undertaking by the bank to sell. This arrangement is called 'Ijarah wa iqtina and it has been allowed by a vast majority of contemporary scholars and is widely used by the Islamic banks However, the validity of this arrangement is subject to two basic conditions: 1.
Therefore, there should be a separate document stipulating this promise by the lessor. It should not be a bilateral promise binding on both parties because in this case it will be a full contract becoming effective on a future date, which is not allowed in the case of sale or gift. Answer: Salam means a contract in which advance payment is made for goods to be delivered at a future date. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract.
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It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. Bai Salam covers almost everything which is capable of being definitely described as to quantity, quality and workmanship. For Islamic banks, this product is ideal for agriculture financing, however, this can also be used to finance the working capital needs of the customers. Bai-Salam has been permitted by the Holy Prophet PBUH himself, without any difference of opinion among the early or the contemporary jurists, notwithstanding the general principle of Shariah that the sale of a commodity which is not in the possession of the seller is not permitted.
Upon migration from Makkah, the Prophet PBUH came to Madinah, where the people used to pay in advance the price of fruit or dates to be delivered over one, two or three years. However, such sale was carried out without specifying the quality, measure or weight of the commodity or the time of delivery. It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of affecting the sale.
In the absence of full payment, it will be tantamount to sale of a debt against a debt, which is expressly prohibited by the Holy Prophet PBUH. Moreover the basic rationale for allowing Salam is to facilitate the "instant need" of the seller. If it is not paid in full, the basic purpose will not be achieved. Only those goods can be sold through a Salam contract in which the quantity and quality can be exactly specified e.
Salam cannot be affected on a particular commodity or on a product of a particular field or farm e. For the legal status and permission of Salam as a special case, see zuhayli, , 1, p.
All details in respect to quality of goods sold must be expressly specified leaving no ambiguity, which may lead to a dispute. It is necessary that the quantity of the commodity is agreed upon in absolute terms. It should be measured or weighed in its usual measure only, meaning what is normally weighed cannot be quantified and vice versa. The exact date and place of delivery must be specified in the contract. Salam cannot be affected in respect of things, which must be delivered at spot. Answer: It is a specific kind of a Bai sale where the sale of the commodity is transacted before the commodity comes into existence.
The legality of Istisna is accepted by the Shariah scholars because it does not contain any prohibition, As far as the financing mode, it has been legalized on the basis of the principles of Istihsan public interest Istisna is an agreement culminating in a sale at an agreed price whereby the purchaser places an order to manufacture, assemble or construct or cause so to do anything to be delivered at a future date.
It becomes an obligation of the manufacturer or the builder as the case may be to deliver the asset of agreed specifications at the agreed period of time. As the sale is executed at the time of entering into the Istisna contract, the contracting parties need not renew an exchange of offer and acceptance after the subject matter is prepared. Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways etc.
Once the work starts, the contract cannot be cancelled unilaterally. Answer: Under Istisna, the manufacturer either uses his own material or he arranges for the material himself whereas under Ijara the material is provided by the customer and the manufacturer uses only his labour and skill meaning that his services will be hired for a specified fee paid to him. Further, under Istisna the purchaser has the right to reject the goods after inspection if these are not according to the specifications agreed at the time of contract whereas under Ijara this right of inspection does not exist.
Answer: The following are the main differences between Istisna' and Salam: 1. The price in Istisna' does not necessarily need to be paid in full in advance. It is not even necessary to pay the full price at delivery. It can be deferred to any time according to the agreement of the parties. The payment may also be made in installments. In case of Salam, the price has to be paid in full in advance.
The time of delivery does not have to be necessarily fixed in Istisna' whereas in case of Salam the time of delivery is an essential part of the sale. Istisna contract can be cancelled before the manufacturer starts the work. Salam contract cannot be cancelled unilaterally. Answer: In Islamic law it is permissible to penalize a debtor who is financially sound but willfully delays payment of debt without any genuine reason.
A heavy non-performing portfolio and default on the part of clients is a serious problem confronting the financial institutions all over the world including Pakistan. This problem may be a threat to the success of Islamic banking system if not properly addressed. The banks, financial institutions, depositors and ultimately the economy will have to suffer its consequences.
This would also help in maintaining a credit discipline in the banking and act as a deterrent against debts becoming bad or unrealizable. However, the penalty proceeds would be used for charity as penalty cannot become source of income for the bank in any manner. Answer: The contemporary Shariah scholars have evolved a consensus that banks are authorized to impose late fees on the delinquent.
However, the proceeds of such penalty are to be used for charity purposes. The court or a recognized adjudicating forum may reasonably adjust the amount of compensation. The actual financial loss cannot be the loss in terms of conventional opportunity cost. It has to be proved by the bankers themselves to the satisfaction of the court or any arbitrator. Answer: Islamic banking is in its early stage and is in the process of strengthening its base in the economies having conventional banking rooted deeply in the current interest-dominated system.
The volume of business captured by the conventional banking system gives it an edge over Islamic banking in terms of cost due to its ability of having achieved economies of scale. The conventional banks can avail the economies of scale due to their wide network and huge volume of business which the Islamic banking, in its nascent stage cannot avail given the present volume of their business.
Further, Islamic banking has to maintain some additional documentation which adds to the cost of its operations. While Islamic banking may appear to be marginally costlier at this stage, the incremental cost is not prohibitive in relation to the benefits. Answer: A promissory note or a bill of exchange represents a debt payable by the debtor to the holder. This debt cannot be transferred to anybody except at its face value. Discounting of bill or a Note or a Cheque, therefore, involves interest. In an Islamic financial market, the papers representing money or debt cannot be traded except at face value.
Islamic banks have various modes of finance through which the business needs of the customer can be satisfied without discounting the bill.
Your questions answered
A majority of Islamic Shariah scholars do not allow Salam in gold, silver, currencies or monetary units, although a few jurists have allowed it. As such, a few Islamic banks have been using Salam in currencies as an alternative to bill discounting Islamic Shariah provides several interest-free modes of finance that can be used to satisfy various business needs of the customer. These modes can be clubbed into two broad categories. The first category may include modes of advancing funds on a profit-and-loss-sharing basis.
Examples of profit and loss sharing category are Mudarabah, Musharakah and participation in the equity capital of companies. Examples of this type are Murabaha, Istisna, Salam and Ijarah. Therefore the financial needs can easily be met through interest-free legitimate modes of finance. These can be used to finance the trade, industry or a budget deficit through domestic or foreign sources.
The following would further elaborate in detail. A Modes for financing trade and industry: Murabaha, Musawama, Ijarah and salam are particularly suitable for trade while istisna is especially suitable for manufacturing or construction industry. Further, the trade and industry needs financing for the purchase of raw materials, inventories stock in trade and fixed assets as well as to meet some working capital requirements. For the procurement of fixed assets including plant and machinery, buildings etc. B Modes for financing a budget deficit: It is noted that in an Islamic state, all the efforts should be made to avoid the budget deficit.
However, in case of unavoidable circumstances, the budget deficit may be kept to the possible minimum limit. There is a need to win public confidence about these needs and to create transparency in government expenditure. There is also a need to prevent the leakage of revenue generating streams for the Government. This can serve better in keeping budget deficits to a minimum level. In case of unavoidable deficits, government- owned enterprises can obtain finance by way of Mudarabah, Musharakah or Sukuk certificates, just like private companies do. An alternative to foreign loans Seeking Islamic solution to foreign borrowing, arrangements could be made to attract foreign as well as domestic funds through the following two ways: i.
The issue of certificates Musharakah partnership or Ijara certificates can be issued to finance the projects of the Government. Such certificates can be denominated in foreign as well as domestic currencies and they would carry a predetermined basis for sharing the profits earned through the respective projects. The certificates issued can be restricted to a particular project or earmarked to a group of projects.
The establishment of funds Funds can be created to finance the economic activities of public and private enterprises on equity, partnership, and Ijarah basis. These funds can attract funds through the issue of shares and certificates of various values and maturities and in domestic as well as foreign currencies. These can be established either to finance a certain sector for example agriculture, industry and infrastructure , a particular industry for example textiles, household durables, etc.
While a conventional bank uses the rate of interest for both obtaining funds from savers and lending these funds to businessmen, an Islamic bank performs these functions using various financial modes which are compatible with the Shariah. For mobilizing resources, it uses either the contract of Mudarabah or Wakalah with the fund owners. Under the first contract, the net income of the bank is shared between fund user Mudarib and fund providers Rabul Maal according to a predetermined profit sharing formula. In the case of loss, the same is shared by fund providers in proportion to the capital contributions.
As far as the nature of investment deposits are concerned, these could be either general investment deposits or specific investment accounts in which deposits are made for investment in particular projects. In addition, there are current accounts that are in the nature of an interest-free loan to the bank. The bank guarantees the principle in case of current accounts but pays no profit on such accounts.
Under the wakalah contract, clients give funds to the bank that serves as their investment manager. The bank charges a predetermined fee for its managerial services. The profit or loss is passed on to the fund providers after deducting such a fee. A wide variety of such modes of financing is available as discussed before.
Answer: The question may be divided into following two parts for proper understanding: 1. Do we need bank? If yes, why it should be on the basis of Islamic Shariah. In order to assess the need of the bank, we need to look at the functions it performs. In any society, be it a secular or Islamic one, the main function of the bank is to mobilize funds from the surplus units and allocate these to the shortfall units or to the units having budget constraints.
This function is performed through the process of financial intermediation in the financial markets where banks are the most important operators. Financial intermediation removes this size mismatch by collecting the small savings and packaging them to suit the needs of entrepreneurs. In addition, entrepreneurs may require funds for periods relatively longer than would suit individual savers. Intermediaries resolve this mismatch of maturity and liquidity preferences again by pooling small funds. Moreover, the risk appetite of savers and entrepreneurs are also different.
It is often considered that small savers are risk averse and prefer safer placements whereas entrepreneurs may wish to deploy funds even in risky projects. The role of the intermediary again becomes crucial. Under the PLS paradigm, the assets and liabilities of Islamic banks are integrated in the sense that borrowers share profits and losses with the banks, which in turn share profits and losses with the depositors.
Similarly, the risk-sharing feature of the PLS paradigm, in theory, allows Islamic banks to lend on a longer-term basis to projects with higher risk-return profiles and, thus, to promote economic growth Chapra, ; Mills and Presley, The PLS paradigm, moreover, subjects Islamic banks to greater market discipline.
Islamic banks, for example, are required to put in more effort to distinguish good customers from bad ones because they have more to lose than conventional banks. The banks also need to monitor their investments and borrowers more closely to ensure truthful reporting of profits and losses. Islamic bank depositors, furthermore, are required to choose their banks more carefully and to monitor the banks more actively to ensure that their funds are being invested prudently. Advocates of Islamic banking, therefore,. First, we find that the adoption of the PLS paradigm of Islamic banking in Malaysia has been much slower on the asset side than on the liability side.
On the asset side, only 0. Islamic bank financing in Malaysia, in practice, is still based largely on non-PLS modes of financing that are permissible under the Shariah Islamic law , but which ignore the spirit of the usury prohibition. Second, the mudarabah profit-sharing deposits, which are structured according to the PLS paradigm, are supposed to be interest-free and equity-like in theory. In practice, however, we find new evidence that shows that the Islamic deposits are not really interest-free, but are very similar to conventional banking deposits. More specifically, we find that, contrary to expectation, the investment rates on Islamic deposits are mostly.
Those results imply that the Islamic banking deposit PLS practices are actually closely pegged to the deposit rate setting practices of conventional banking. Our overall results, thus, suggest that Islamic banking, as it is practiced today in Malaysia, is not very different from conventional banking, and the alleged benefits of Islamic banking exist in theory only. There are two important implications associated with this finding: First, the key reason for the rapid growth in Islamic banking worldwide during the past decades is unlikely to be associated with the attributes of the Islamic PLS banking paradigm.
However, our study shows that the mudarabah. As such, all assets that are funded by mudarabah deposits or profit sharing investment accounts should not be excluded from the calculation of. The rest of the paper is organised as follows: Section 2 provides a description of Islamic banking concepts and practices. Section 3 details the Engle-Granger error-correction methodology used to study the long-term relation and short-term dynamics between Islamic investment rates and conventional deposit rates.
Section 4 analyzes the results, and the final section concludes the paper. We then provide a discussion of Islamic banking practices in Malaysia. Muslims, for example, are not allowed to invest in businesses considered non-halal or prohibited by Islam, such as the sale of alcohol, pork, and tobacco; gambling; and prostitution. For example, the sale of fish from the ocean that has not yet been caught is prohibited.
Gambling and derivatives such. More importantly, Muslims are prohibited from taking or offering riba. What constitutes riba, however, is controversial and has been widely debated in the Islamic community. Some view riba as usury or excessively high rate of interest. But the majority of Islamic scholars view riba as interest or any pre-determined return on a loan. The basis for the prohibition of riba in Islam may be traced to the common medieval Arabic practice of doubling the debt if the loan has not been repaid when due.
This practice in its extreme form had led to slavery in medieval Arabia because of the absence of bankruptcy legislation that protects the borrower from failed ventures. Thus, a unique feature that differentiates Islamic banking from conventional banking, in theory, is its profit-and-loss sharing PLS paradigm. Under the PLS paradigm, the ex-ante fixed rate of return in financial contracting, which is prohibited, is replaced with a rate of return that is uncertain and determined ex-post on a profit-sharing basis.
The PLS paradigm is widely accepted in Islamic legal and economic literature as the bedrock of Islamic financing. Islamic bank financing, which adheres to the PLS principle, is typically structured along the lines of two major types of contracts: musyarakah joint venture and mudarabah profit-sharing. Musyarakah contracts are similar to joint venture agreements, in which a bank and an entrepreneur jointly contribute capital and manage a business project.
Any profit and loss from the project is shared in a predetermined manner. The joint venture is an independent legal entity, and the bank may terminate the joint venture gradually after a certain period or upon the fulfilment of a certain condition. Mudarabah contracts are profit-sharing agreements, in which a bank provides the entire capital needed to finance a project, and the customer provides the expertise, management and labour.
The profits from the project are shared by both parties on a pre-agreed fixed ratio basis, but in the cases of losses, the total loss is borne by the bank. There are, however, other financing contracts that are permissible in Islam but not strictly PLS in nature. Such financing contracts, for example, may be based on murabaha cost plus ,.
Murabaha financing is based on a mark-up or cost plus principle, in which a bank is authorized to buy goods for a customer and resell them to the customer at a predetermined price that includes the original cost plus a negotiated profit margin. Ijarah financing is similar to leasing. A bank buys an asset for a customer and then leases it to the customer for a certain period at a fixed rental charge.
Shariah Islamic law permits rental charges on property services, on the precondition that the lessor bank retain the risk of asset. The price of the product is agreed upon at the time of the sale and cannot include any charge for deferring payments. This contract has been used for house and property financing. This method allows an entrepreneur to sell some specified goods to a bank at a price determined and paid at the time of contract, with delivery of the goods in the future.
It can be used in the financing of manufactured goods, construction and infrastructure projects. To disseminate Islamic banking nationwide, BNM introduced the Interest-free Banking Scheme in March , which allows existing banking institutions to offer Islamic banking services using their existing infrastructure and branch network. Furthermore, a second Islamic bank, Bank Muamalat Malaysia Berhad, was established in October , and three new Islamic bank licences were issued to Islamic financial institutions from the Middle East in to enhance the diversity and depth of players in the Islamic financial system.
Besides the Interest-free Banking Scheme, Malaysia has a well-developed Islamic interbank money market, Islamic government debt securities market, and Islamic insurance market. The Islamic interbank money market, introduced in January , allows Islamic banking institutions to trade in designated Islamic financial instruments among themselves. The Mudharabah Interbank Investments MII mechanism, moreover, allows a deficit Islamic banking institution to obtain investment from a surplus Islamic banking institution on a mudarabah profit-sharing basis. The growth in the Islamic banking sector in Malaysia has been rapid since the establishment of Islamic Banking Act in Figure 1 captures the exponential growth.
Starting from a small base of RM0. Table 1 provides a further breakdown of the percentage of banking assets that are under the management of the Islamic banking system by type of institutions. Islamic banks, in general, are restricted from participating in the conventional banking system, while the other financial institutions can participate in both the conventional banking system and Islamic banking system. Thus, we find that for Islamic banks, all their assets are managed under the Islamic banking system.
For the other financial institutions, the percentage of their assets that are. Islamic banking assets only accounts for 7. Among the commercial banks, we find that Islamic banking assets accounts for a larger share 8. Despite having only a small percentage of their asset portfolio in Islamic banking, commercial banks actually held the largest market share Table 2 provides a breakdown of the types of Islamic financing and Islamic deposits in Malaysia.
Total financing in the Islamic banking sector amounts to RM The Islamic banking sector, in general, has been expanding much more rapidly than. The mudarabah profit-sharing and musyarakah joint venture financing modes, in total, amount to only 0. Thus, Islamic bank financing in Malaysia, in practice, does not appear.
PLS modes of financing account for only a negligible portion of total Islamic bank financing. Islamic bank financing in Malaysia, in particular, is still largely based on the non-PLS modes of financing that are permissible under the Shariah law, but ignore the spirit of the usury prohibition.
The adoption of the PLS paradigm, however, appears to be faster on the liability side of Islamic banking. Total Islamic banking deposits in Malaysia amount to RM The breakdown of the Islamic banking deposits by type in Panel B of Table 2 shows that demand deposits, saving deposits, investment deposits, and negotiable instruments of deposit NID account for Investment deposits and NID are term deposits that operate under the mudarabah profit-sharing concept. Theoretically, such mudarabah deposit accounts are much riskier than conventional-banking fixed deposits for a number of reasons.
Second, profit sharing under mudarabah contracts is asymmetric, i. The mudarabah deposits accounts, in theory, should be interest-free from an Islamic banking perspective. In practice, however, are such mudarabah contracts, which form the bedrock of the Islamic banking PLS paradigm, truly interest-free? Also, are the returns on al-wadiah savings with guarantee deposits independent of interest rates? To address these questions, we examined the relation between the investment rates offered by Islamic deposits and the corresponding deposit rates offered by conventional bank deposits. The next section describes the Engle-Granger error correction methodology used to study such a relation.
The following two null hypotheses were tested: i changes in the Islamic investment rate do not Granger cause the conventional deposit rate to change and ii changes in the conventional deposit. To further ascertain that the relation between the conventional deposit rate and Islamic investment rate is not spurious, we then carried out unit root and cointegration tests. Once cointegration between the two time series was established, we then estimated their long-term relation and short-term dynamics on a maturity-matched basis. First, the long-term relationship between two time-series variables was modelled as follows:.
The degree of pass-through in the long run, , measures the extent to which a change in the independent variable gets reflected in the dependent variable. The long-run pass-through is considered complete when is equal to one and incomplete when it is less than one. Second, we used the following error-correction representation to examine the short-term dynamics:. In the mean reverting case, the sign of is expected to be negative.
Also, following Hendry , the mean adjustment lag of a complete pass-through can be calculated using the following equation: 3. The series of monthly data are aggregated and reported based on the average rates across all financial institutions. The sample size was for each time series. For robustness, we examined the rates provided by two types of financial institutions: banks and finance companies. Table 3 provides the descriptive statistics for the sample data. The summary statistics, in particular, show that the Islamic investment rates are, on average, significantly lower than the conventional deposit rates.
This finding is true for both the banks and the finance companies. These results are counterintuitive because the Islamic deposits, based on the PLS theory, should have higher risks than conventional deposits. A possible reason for the above results is that, in practice, the returns on Islamic deposits are administratively linked to the deposit rates offered by conventional banking. The last column of Table 3, in particular, shows. The correlation coefficients, for example, range from 0.
However, to rule out the possibility of spurious correlations, we next conducted several standard econometric tests to determine Granger causality, unit root, and cointegration. Table 4 reports the results of the pair-wise Granger causality test. The results show that for each of the six maturity-matched cases, we cannot reject the null hypothesis that changes in Islamic investment rates do not cause adjustments in the conventional deposit rates. This is true for both the banks and the finance companies. In other words, changes in conventional deposit rates cause Islamic investment rates to change, but not vice versa.
Having determined the endogenous and exogenous variables, we then carried out the standard stationarity and cointegration tests.
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We applied both the Augmented Dickey Fuller ADF and Philips-Peron procedures to test the null hypothesis of unit root against the alternative hypothesis of stationarity. Although not reported, both ADF and Philips-Peron test results show that all the data series are non-stationary in levels and stationary in first differences.
The results of the cointegration tests are reported in Table 5. The cointegration test results, hence, show that there is a long-term relation between the Islamic investment rate and the conventional deposit rate for both the banks and the finance companies. The estimated coefficients of the long-term relation Equation 1 are reported in Table 6. The results show that there exists a long-term positive relation between Islamic investment rates and maturity-matched conventional deposit rates.
The adjusted R2 is very high. For both banks and finance companies, the degree of pass-through for savings deposits is higher than that of time-deposits. The results of the short-term dynamics and the mean adjustment lags are reported in Table 7. This implies that when the Islamic investment rate is above its long-term equilibrium level, it will adjust downwards. When it is below its long-term. The mean adjustment lag MAL results, furthermore, show that for banks, the short-run adjustment process takes about 3. For finance companies, the MAL ranges from 1. The MAL, moreover, is shorter for savings deposits than for the various time deposits.
Our overall results, thus, suggest that the Islamic deposits, in practice, are not very different from conventional deposits. In particular, we found that the Islamic investment rates for both the banks and the finance companies are closely pegged to the conventional deposit rates. Furthermore, the mudarabah deposits, in theory, are supposed to be equity-like because of their PLS paradigm. Our results show that the mudarabah deposits are more debt-like than equity-like. For robustness, we examined if there is any long-term relation between the various Islamic investment rates and the return on the Malaysian benchmark KLCI equity index.
Although not reported here, our results show that none of the Islamic investment rates is cointegrated with the return on the KLCI equity index and, hence, there is no long-term relation between them. One explanation is that the actual implementation of the PLS paradigm is constrained by competition from conventional banking practices. Thus, in terms of best practices, Islamic banking practices often cannot deviate substantially from those of conventional banking because of competition.
An Islamic bank could be exposed to the risk of withdrawals by its depositors as a result of the lower rate of return they would receive compared to what its competitors pay. This is further compounded by competition in managing the liquidity in the system. The profit share distributed needs to be competitive relative to that earned and paid by the conventional banks.
Our results, for example, show that changes in the conventional deposit rates cause Islamic investment rates to change, but not vice versa. Estimates of the long-term relation between the two rates of return, moreover, show that many of the changes in Islamic investment rates can be explained by changes in conventional deposit rates. Short-run dynamic analysis, in addition, shows that the Islamic investment rates are mean-reverting, i.
However, anecdotal evidence shows that, contrary to the asset-liability matching explanation, the Islamic bank depositors in practice do not fully share in the financing losses incurred by Islamic banks. Moreover, the above asset-liability matching explanation cannot explain why the Islamic investment rates are pegged to conventional deposit rates. More specifically, it cannot explain why the changes in the conventional deposit rates cause Islamic investment rates to change, but not vice versa.
In this paper, we attempted to establish whether Islamic banking is really different from conventional banking. In theory, a unique feature that differentiates Islamic banking from conventional banking is the PLS paradigm. In practice, however, we found that Islamic banking is not very different from conventional banking from the perspective of the PLS paradigm. On the asset side of Islamic banking, we found that only a negligible portion of financing is based on the PLS principle.
Consistent with Islamic banking experiences. On the liability side, the PLS principle is more widely adopted in structuring Islamic deposits. Our study, however, provides new evidence, which shows that, in practice, Islamic deposits are not interest-free. There are several possible reasons for the poor adoption of the PLS paradigm in practice. Moral hazard problems associated with ex-post information asymmetry, for example, are especially significant in PLS financing because the entrepreneur borrower has incentive to under-declare or artificially reduce reported profit Mills and Presley, Also, in the case of mudarabah profit-sharing contracting, the entrepreneur has an incentive to undertake high-risk projects because the entrepreneur is actually given a call option whereby he or she gains on the upside but bears no losses at all on the downside.
PLS financing, thus, requires more costly monitoring. Second, the adoption of PLS financing is disadvantaged by a lack of management and control rights Dar and Presley, In mudarabah profit-sharing financing, for example, the bank provides all the risk capital, but the management and control of the project is mostly in the hands of the entrepreneur. Finally, our study suggests that the adoption of the PLS paradigm is constrained by competition as well as by best practices from conventional banking.
In particular, our study shows that the returns on the Islamic deposit accounts are effectively pegged to the returns on conventional banking deposits because of competitive reasons. Chapra, M. Umer, Shrestha, Monetary transmission via the administered interest rates channel. Journal of Banking and. Engle, Robert F.
Granger, Cointegration and error correction: representation, estimation and testing. Academic Press. Heffernan, Shelagh A. Modelling British interest rate adjustment: An error correction approach. Hendry, David F. Dynamic econometrics, Oxford: Oxford University Press. Khan, Mohsin S. Obaidullah, Mohammed. Rating of Islamic financial institutions: some methodological suggestions.
World Bank, Country brief report: Malaysia. The study evaluates intertemporal and interbank performance of Islamic bank Bank Islam Malaysia Berhad BIMB inprofitability, liquidity, risk and solvency; and community involvement for the period Financial ratios areapplied in measuring these performances. T-test and F-test are used in determining their significance. The study found thatBIMB is relatively more liquid and less risky compared to a group of 8 conventional banks. Our analysis of the primary dataidentified reasons why the supply of loans under profit sharing and joint venture profit sharing is not popular in Malaysia.
Evaluation of bank performance is important for all parties: depositors, bank managers and regulators. In a com-. Similarly, it flashes direction to bank managers whether to improve its deposit service or loan. Regulator is also interested to know for its regulation purposes. The important underlying force. Tabung Haji took the initiative to do business without using interest considered as being predetermined rate of. Tabung Haji is an organization for the Muslim for taking care of pilgrims to Mecca.
It is. Its objective is to implement Muslim code of life shariah in Hajj and all business transactions. All trans-. Tabung Hajj wanted. Islamic bank is sought as a solution to it. With the increase in Muslim populations and. Bank Islam Malaysia was established in July to meet these demands and challenges.
Since then BIMB. Musharakah and others. Its assets and deposits have increased.
The financing of loans and services increased to RM mil in However, 15 years have passed since BIMB was established. There has been no study as to how the bank. The previous studies on profitability and other measures, Samad , Ariff , Dirrar. These studies used neither. However, such issues of profitability, liquidity, risk and solvency; and community involvement of the bank during. So, the present study intends to evaluate the perfor-.
This study is different from the earlier studies with. The first hypothesis states that the liquidity ratios of Islamic banks are expected to. The second hypothesis states that as. Islamic banking makes its inroad in the society, the volume of two truly islamic financial modes of lending. Hassan examines the Islamic banking principles in theory and its application with a case study of Bangladesh. The abundance of short-term funds compared to long-term funds available for lending is a rational response on. In traditional finance literature, it is.
However, equity contract can be superior to. In Islam, business is an Ibadah worship and is recommended whereas riba interest is prohibited. From business point of view Islamic bank is not only a firm but also a moral trustee of the depositors where deposits. Islamic bank is likely to be more liquid and become more solvent compared to its counterpart conventional banks. Islamic bank management, according to Islamic ethics, is accountable to the depositors in this world and the world.
It is, therefore, expected that the liquidity and. However, it is also expected that the liquidity ratio of the Islamic bank may decline during the later periods com-. As the bank grows, it acquires more skill and the art of banking business, it will keep less. This paper wants to test the hypothesis that the liquidity ratio and. Instead of interest based contract, Islamic bank is founded on different philosophy; and it delivers a set of distin-. Unlike conventional banks where interest is an integral part of bank. It does not deal with interest. As a business firm BIMB delivers special financial prod-.
It delivers interest-free products. For example, trust profit. The important feature of this loan Mudarabah and Musharakh is that they are. There are no elements of interest involved in this transaction. Based around 12 individual cases, the book stimulates discussio. Based around 12 individual cases, the book stimulates discussion and develops the reader's understanding of Islamic finance by contrasting the theoretical concepts discussed in the author's companion text Introduction to Islamic Banking and Finance with practical real world situations.
The cases cover core Islamic banking and finance topics including the Ijara, Mudaraba and Musharaka contracts; Islamic mortgages for home finance; leverage; and issues involved in opening an Islamic bank. Financial statement analysis for Islamic banks, the implications for fund management for equity investing and the impact of loan defaults on Islamic and conventional banks are also included.
Each chapter concludes with a set of questions designed to test the reader's understanding of each case, with suggested solutions at the end of the book. This book is a must have resource for those wishing to apply their understanding of this complex subject and is an essential read for anyone seeking practical examples of how to apply the concepts in a real world environment.
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