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Fundamentals of Islamic Finance and Banking

Syeda Fahmida Habib

ISBN: 978-1-119-37103-8 July 2018 312 Pages



A comprehensive and fully up-to-date introductory textbook to Islamic finance and banking

Islamic finance and banking is being used increasingly globally — especially in the regions of Middle East and North Africa, South East and South Asia. To cater to the need of trained Islamic finance staff, a large number of Educational institutions are beginning to offer courses, majors and minors in Islamic finance and banking. The major challenge faced by these institutions are suitable textbooks for both undergrad and post-grad levels and especially with the relevant instructor resources (PPTs, test bank, practice activities and answer keys).

Luckily, Fundamentals of Islamic Finance and Banking is here to cover the most important topics related to Islamic finance and banking (IF&B) that are relevant for students of business, finance and banking. 

  • Offers an historical background of Islamic finance
  • Covers the principles of Sharia Law as pertinent to finance and banking
  • Provides in-depth discussion of the six key Islamic banking products: Murabaha, Mudaraba, Musharaka, Ijara, Salam and Istisna
  • Discusses the Islamic insurance (Takaful)
  • Gives an overview of Islamic investment, especially Sukuks
  • Concludes with the global standing of the Islamic Finance and Banking industry

Would-be colleges and universities offering this subject as a course within their finance and/or banking program can’t be without this invaluable guide.  

Related Resources

List of Figures xv

List of Tables xvii

Acknowledgements xix

About the Author xxi

Preface xxiii

About the Website xxv

CHAPTER 1: Introduction to Islamic Finance and Islamic Economics

1 Introduction 1

Creation of Money and Conventional Finance and Banking 2

Definition of Islamic Finance and Banking 3

Distinctive Features of Islamic Finance 3

Economics and Islam 4

Economics in Ancient Times 4

Modern Economics 5

Islamic Economics 6

History of Islamic Economic Thought 6

Principles of Islamic Economics 7

Islam’s Solution to the Classic Economic Problem 7

Islam and the Welfare Economy 8

Property Ownership in Islamic Economics 8

Zakat and Sadaqah 8

Ban on Interest versus Cost of Capital in Islam 9

Conventional Economics versus Islamic Economics 9

Evolution of Islamic Finance 11

Early Days 11

Birth of Modern Islamic Finance 12

Institutional Developments During the Revival of Modern Islamic Finance 12

The Mit Ghamr Experiment 13

Tabung Haji 13

Islamic Development Bank 14

Dubai Islamic Bank 14

Rapid Growth of the Islamic Finance and Banking Industry 14

Islamic Finance and Banking in Muslim Communities and Countries 15

Islamic Finance and Banking in Non-Muslim Countries 16

Sub-sectors in the Islamic Finance and Banking Industry 16

Current Status of Modern Islamic Finance and Banking 17

Timeline of Development of Contemporary Islamic Finance and Banking 18

Key Terms and Concepts 21

Chapter Summary 21

CHAPTER 2: Shariah Law and the Shariah Supervisory Board 27

Introduction to the Islamic Law – Shariah 27

Sources of Shariah 28

Schools of Islamic Jurisprudence 29

Ethics in Shariah-Compliant Business and Finance 30

Major Shariah Prohibitions and Principles and their Implications 31

Prohibition of Interest or Riba 31

Prohibition of Uncertain Dealings or Gharar 32

Prohibition of Speculative Behaviour or Maysir 33

Shariah Supervisory Board (SSB) 34

Introduction to the SSB 34

Formation of the SSB 35

Status of the SSB Within the Industry 36

Functions of the SSB 36

Corporate and Shariah Governance 38

Shariah Governance Process 38

Key Terms and Concepts 39

Chapter Summary 39

CHAPTER 3: Islamic Banking versus Conventional Banking 47

Introduction to Islamic Banking 47

Islamic Banking versus Conventional Banking 49

Similarities Between Conventional and Islamic Banks 49

Differences Between Conventional and Islamic Banking 49

Relationship with the Central Banks 50

Risks of Banks – Generic and Specific to Islamic Banks 51

Generic Risks 51

Risks Specific to Islamic Banks 52

Financial Intermediation 54

The Definition of Financial Intermediation 54

Conventional Financial Intermediation 54

Islamic Financial Intermediation 54

Islamic Financial Intermediation Models 56

Distribution of Islamic Banking Products 58

Conventional versus Islamic Financial Intermediation 58

Balance Sheet of an Islamic Bank – Sources and Uses of Funds by an Islamic Bank 59

Sources of Funds 59

Application of Funds 60

Contracts in Shariah Law 61

Contracts of Exchange in Shariah-Compliant Commerce and Finance 62

Common Islamic Banking Products 63

Retail Islamic Banking Products 63

Corporate Islamic Banking Products 64

Financial Accounting in Islamic Banking 65

Objectives of Islamic Financial Accounting 66

Features of Islamic Financial Accounting 66

Challenges Faced by Islamic Banks 67

Islamic Finance and the Financial Crisis 68

International Islamic Regulatory and Standard Setting Bodies 68

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) 69

Islamic Financial Services Board (IFSB) 69 Liquidity Management Centre (LMC) and International Islamic Liquidity Management (IILM) 70

International Islamic Financial Market (IIFM) 70

International Islamic Rating Agency (IIRA) 70

General Council for Islamic Banks and Financial Institutions (CIBAFI) 71

International Islamic Centre for Reconciliation and Commercial Arbitration for Islamic Finance Industry (IICRCA) 71

Islamic Development Bank (IDB) 71

International Islamic Fiqh Academy 72

Key Terms and Concepts 73

Chapter Summary 73

CHAPTER 4: Murabaha 79

Introduction to Murabaha 79

Conditions Related to Murabaha 81

Calculation of Murabaha Profit 83

The Murabaha Process 83

Practical Applications of Murabaha 85

Tawarruq, Reverse Murabaha or Commodity Murabaha 85

Challenges and Problems Associated with Murabaha 86

Comparison of Murabaha with Conventional Loans 88

Key Terms and Concepts 90

Chapter Summary 90

CHAPTER 5: Mudaraba 95

Introduction to Mudaraba 95

Use of Mudaraba for Financial Intermediation of Islamic Banks 96

Profit Calculation in Mudaraba 97

Provisions and Reserves Related to Mudaraba 98

Mudaraba as a Limited Recourse Debt Finance 99

Types of Mudaraba 99

Shariah Conditions Related to Mudaraba 100

Additional Conditions Related to Mudaraba 101

Challenges and Problems Related to Mudaraba 102

Practical Applications of Mudaraba 102

Comparison of Mudaraba with Interest-Based Conventional Banking 102

Accounting Issues Related to Mudaraba 104

Key Terms and Concepts 104

Chapter Summary 105

CHAPTER 6: Musharaka 111

Introduction to Musharaka 111

Types of Musharaka 112

Shariah Rules and General Principles Guiding Musharaka Contracts 114

Problems Related to Musharaka 115

Practical Uses of Musharaka 116

Examples of the Use of Diminishing Musharaka 118

Securitization of Musharaka 121

Comparison of Musharaka with Interest-Based Financing 121

Comparison of Musharaka with Mudaraba Financing 122

Key Terms and Concepts 123

Chapter Summary 123

CHAPTER 7: Ijara 129

Introduction to Ijara 129

Ijara in Islamic Banks 130

Types of Ijara 130

Ijara, Regular Ijara or Operating Lease 130

Ijara wa Iqtina, Ijara Muntahia Bittamleek or Financial Lease 131

Ijara Thumma al Bay 132

Shariah Rules and General Principles Guiding Ijara Contracts and their Characteristics 132

Documentation Related to the Ijara Contract 136

Main Differences Between Ijara and a Conventional Lease 136

Differences Between Ijara and a Conventional Loan Contract 138

Differences and Similarities Between Ijara Wa Iqtina and Diminishing Musharaka 139

Practical Applications of the Ijara Contract 139

Calculation of Lease Rentals 139

Practice Calculations 139

Key Terms and Concepts 140

Chapter Summary 140

CHAPTER 8: Salam 145

Introduction to Salam 145

Important Characteristics of the Salam Contract 146

History of the Salam Contract and its Shariah Acceptability 147

Benefits of the Salam Contract 148

Role of Islamic Banks in Salam and the Parallel Salam Contract 148

Salam and Parallel Salam Diagram and Process 149

Practical Application of Salam 150

A Practical Example 150

Problems Related to Salam Contracts 151

Comparison of Salam Contract with Conventional Banking 151

Key Terms and Concepts 151

Chapter Summary 152

CHAPTER 9: Istisna 155

Introduction to Istisna 155

Shariah Rules and General Principles Guiding Istisna Contracts and their Characteristics 156

Role of Islamic Banks in Istisna and Parallel Istisna 158

Description of the Process 159

Problems Related to Istisna and Parallel Istisna 160

Comparison of Istisna with Interest-Based Finance, Salam and Ijara 161

Difference Between Salam and Istisna 162

Comparison of Istisna with Ijara 163

Practical Application of Istisna 163

Key Terms and Concepts 164

Chapter Summary 164

CHAPTER 10: Takaful 169

Background of Takaful 169

Modern Takaful Industry as an Alternative to Conventional Insurance 170

Parties in Takaful 171

Shariah Rules and General Principles Guiding Takaful Contracts and their Characteristics 172

The Development of Takaful 174

During the Time of the Prophet 174

The 18th and 19th Centuries 174

20th Century 174

The 21st Century and Moving Forward 175

Challenges Faced by the Modern Takaful Industry 176

Types of Takaful 177

General Takaful 177

Family Takaful 178

Operational Structure of Takaful 180

Takaful Models 181

Pure Wakala Model 181

Pure Mudaraba Model 183

Wakala and Mudaraba Combined or Hybrid Model 185

Waqf–Wakala–Mudaraba Model 185

Comparison of the Different Takaful Models 187

Underwriting Surplus or Deficit and Technical Provisions 189

Allocation of Underwriting Surplus 189

Management of Underwriting Deficit 190

Conventional Mutual Insurance and Takaful 190

Similarities and Difference Between Takaful and Conventional Insurance 191

Similarities 191

Differences 191

Retakaful 196

Similarities Between Retakaful and Reinsurance 197

Differences Between Retakaful and Reinsurance 197

Key Terms and Concepts 198

Chapter Summary 199

CHAPTER 11: Islamic Investments and Sukuks 205

Investment Markets and Products 205

Islamic Investments 207

Money Markets – Islamic Perspective 207

Capital Markets – Islamic Perspective 208

Dealing with Non-compliant Stocks 209

Purification of Income Distribution 210

Islamic Asset and Fund Management 210

Islamic Unit Trust or Mutual Fund 211

Common Types of Islamic Investment Fund 212

Islamic Real Estate Investment Trusts 213

Similarities Between REITs and I-REITs 214

Differences Between REITs and I-REITs 215

Risks and Challenges Inherent in the Islamic Capital Markets 216

Shariah Governance and the Shariah Supervisory Board in Islamic Investment 216

Comparison of Islamic Investments with Conventional Investments 217

Introduction to Sukuks 218

Characteristics of the Islamic Investment Product – Sukuk 218

Types of Sukuks 220

Ijara Sukuk 220

Istisna Sukuk 222

Salam Sukuk 223

Murabaha Sukuk 223

Mudaraba Sukuk 224

Musharaka Sukuk 226

Controversy Related to Sukuks 227

Rating of Sukuks 229

Trading of Sukuks on the Secondary Markets 229

Comparison of Sukuks with Conventional Bonds 230

Common Advantages of Both Conventional Bonds and Sukuks 230

Differences Between Conventional Bonds and Sukuks 231

Key Terms and Concepts 235

Chapter Summary 235

CHAPTER 12: Global Standing of Islamic Finance and Banking 241

Background of Modern Islamic Finance and Banking 241

Conventional versus Islamic Finance 242

Global Growth of the Islamic Finance and Banking Industry 243

Islamic Finance and Banking and the Muslim Community 245

Banking and Islamic Banking in the Middle East and the GCC 246

Banking and Islamic Banking in South and South-East Asia and Beyond 247

Achievements and Opportunities in Global Islamic Finance and Banking 247

Challenges Faced by Islamic Finance and Banking 248

Social Responsibilities of Islamic Finance 253

Going Forward 254

Key Terms and Concepts 255

Chapter Summary 255