DIFFERENCE OF ACCOUNTING SYSTEM BETWEEN ISLAMIC BANKING AND CONVENTIONAL BANKING Islamic Banking Conventional Banking 1. Islamic Banks are to follow Quran, Sunnah, Ijma and Kias i.e. Shariah, in all the business transactions including Accounting Entries. 1. Conventional Banking follows the man made practice and rules. 2. They can not engage in any interest transactions 2. They conduct their transactions on interest basis 3. If any interest is included/entered in the operations of the banks, that should be excluded from the regular income of the Bank 3. Interest is their main income 4. If any income is earned violating Shariah Principles that can not be included in the distributable income of the Bank. 4. They do not follow shariah rules & regulations. 5. In Musharaka, Mudaraba, Bai- Salam modes of Investment, Income can not be accounted for on accrual basis. 5. In Conventional Banking there is no practice of Musharaka, Mudaraba, Bai-Salam modes of Investment and most of their income can be recognized on accrual basis. 6. For delay of Payment of Investment by the clients, in case of Bai-Murabaha and Bai- Muazzal etc. Investment further amount of profit can not be charged. 6. No such Bai-Muraba and Bai- Muazzal Investment in conventional Banks. They Charge interest/penal interest for delay in payment /repayment. 7. In case of overdue Investment compensation may be charged if an independent committee like Review Committee decides to impose the Compensation. 7. They charge interest /penal interest on over due Investment. 8. Islamic Bank is to pay Zakat 2.50% on its reserves. 8. They do not pay any Zakat on reserves. Islamic Banking Conventional Banking 9. Islamic Banks are to pay a certain minimum percentage of Investment Income to the Mudaraba Depositors. 9. They do not pay a certain amount to the depositor from their Investment income, rather they pay fixed rate of interest /home/website/convert/temp/convert_html/551ee447497959d9398b4dfb/document.doc
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DIFFERENCE OF ACCOUNTING SYSTEM BETWEEN ISLAMIC BANKING AND CONVENTIONAL BANKING
Islamic Banking Conventional Banking1. Islamic Banks are to follow Quran, Sunnah, Ijma and Kias i.e. Shariah, in all the business transactions including Accounting Entries.
1. Conventional Banking follows the man made practice and rules.
2. They can not engage in any interest transactions
2. They conduct their transactions on interest basis
3. If any interest is included/entered in the operations of the banks, that should be excluded from the regular income of the Bank
3. Interest is their main income
4. If any income is earned violating Shariah Principles that can not be included in the distributable income of the Bank.
4. They do not follow shariah rules & regulations.
5. In Musharaka, Mudaraba, Bai-Salam modes of Investment, Income can not be accounted for on accrual basis.
5. In Conventional Banking there is no practice of Musharaka, Mudaraba, Bai-Salam modes of Investment and most of their income can be recognized on accrual basis.
6. For delay of Payment of Investment by the clients, in case of Bai-Murabaha and Bai-Muazzal etc. Investment further amount of profit can not be charged.
6. No such Bai-Muraba and Bai-Muazzal Investment in conventional Banks. They Charge interest/penal interest for delay in payment /repayment.
7. In case of overdue Investment compensation may be charged if an independent committee like Review Committee decides to impose the Compensation.
7. They charge interest /penal interest on over due Investment.
8. Islamic Bank is to pay Zakat 2.50% on its reserves.
8. They do not pay any Zakat on reserves.
Islamic Banking Conventional Banking9. Islamic Banks are to pay a certain minimum percentage of Investment Income to the Mudaraba Depositors.
9. They do not pay a certain amount to the depositor from their Investment income, rather they pay fixed rate of interest irrespective of Investment Income.
10. Mudaraba Depositors are to share the loss, if any, incurred out of Investment made from Mudaraba Deposits.
10. Their depositors do not share any profit or bear any loss.
11. Islamic Banks are to follow Accounting, Auditing and Shariah Standards developed by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in addition to International Financial Reporting Standards (IFRS) developed by International Federation of Accountants, Bangladesh Bank guidelines, The rules of the Income Tax, The rules of the companies Act, The rules of the SEC.
11. They only follow International Financial Reporting Standards (IFRS), Bangladesh Bank guidelines, The rules of the Income Tax, The rules of the companies Act, The rules of the SEC.
Reference :i. The Holy Quranii. Accounting, Auditing and Governance Standards for Islamic Financial Institutions.iii. The Bank Company Act-1991iv. The Companies Act-1994v. The Income Tax Ordinance -1984vi. SEC Rules.vii. International Financial Reporting Standards.
a) Ensuring optimum supply of money in the economy to facilitate smooth transactionb) Maintaining stability in the value of money and price level.c) Economic well-being with full employment and optimum rate of economic growth.d) Attaining distributive justice.
ENSURING OPTIMUM SUPPLY OF MONEY : In an Islamic economy Govt. as the solitary authority, has to ensure sufficient amount of money to enable people in transacting their goods and services. In a capitalist economy the transaction demand, the precautionary demand and the speculative demand for money is taken into consideration to determine the amount of money to be supplied. However, in an Islamic Economy, only the transaction demand, the precautionary demand is entertained. Speculative demand for money is discouraged by Islam.
STABILITY IN THE VALUE OF MONEY :
In an Islamic economy it is almost mandatory on the central Bank to preserve the value of money to ensure honesty and fairness in all human dealings to bring socio-economic justice and general welfare. But, rather than absolute, this objective would mean relative stability in the general price level. Absolute price stability is neither feasible nor desirable as it may conflict with the optimum growth and full employment objective of the monetary policy.
ECONOMIC GROWTH AND EMPLOYMENT :
While inflation is incompatible with the goals of an Islamic economy, prolonged recession and unemployment that cause human sufferings are also unacceptable. Monetary policy has, therefore, to aim at a high rate of economic growth with full employment and utilization of productive resources. Islam is in favor of “sustainable development “which means meeting the needs of the present generation without compromising the needs of future generations. Economic development and sound environmental management are complementary aspects of the same agenda. Without adequate environmental protection, development will be undermined; without development, environmental protection will fail.
DISTRIBUTIVE JUSTICE :
Monetary policy should be used actively to promote the goal of distributive justice and prevent concentration of wealth and economic power in an Islamic economy. However, too much concern with distributive justice in formulating and implementing monetary policy may adversely affect its overall efficiency and effectiveness in attaining the other goals of monetary policy e.g. growth, employment and development. Reduction in income inequalities and necessary redistribution should be and important policy objective of an Islamic state and hence the domain, mainly, of its fiscal policy. Monetary policy can contribute to this objective.
ROLE OF THE CENTRAL BANK :/tt/file_convert/551ee447497959d9398b4dfb/document.doc
Like all central Banks, the central Bank in an Islamic economy should be responsible for the issue of currency and, in coordination with the government, for its internal and external stability. Unlike the conventional central bank, it should also bear the responsibility of preventing the concentration of wealth and power through the financial institutions. Stabilization of the real value of money should be an important function of the central bank in order to realize the healthy sustainable growth of the Islamic economy and to ensure socio-economic justice.
The central bank should be the primary institution responsible for implementing the country’s monetary policy. Further, since the central bank cannot realize the goal of monetary stability without cooperation from the government, a harmonious fiscal-budgetary policy would be indispensable.
SOURCES OF MONETARY EXPANSION :
i) FISCAL DEFICITS : Fiscal deficits can be, and have been, an important source of excessive monetary expansion. According to one important study “the greater the dependence of the public sector on the banking system, the harder it is for the central bank to pursue a consistent monetary policy.
ii) COMMERCIAL BANK CREDIT CREATION : Commercial bank deposits constitute a significant part of money supply. These deposits may, for the sake of analysis, be divided into two parts.
a) Primary deposit’, which provide the banking system with the base money (cash-in tills plus deposits with the central bank)
b) ‘Derivative deposits which, in a proportional reserve system, represent money created by commercial banks in the process of credit expansion and constitute a major source of monetary expansion.
Since derivative deposits lead to an increase in money supply in the same manner as currency issued by the government or the central bank, and since this expansion, just like government deficits, has the potential of being inflationary in the absence of an offsetting growth in output, the expansion in derivative deposits must be regulated if the desired monetary growth is to be achieved. This could be accomplished by regulating the availability of base money to the commercial banks.
iii) BALANCE OF PAYMENTS SURPLUS : Only a few Muslim countries have enjoyed a balance of payments surplus in recent years, most of them have experienced deficits. In the few that did have a surplus, the surplus did not originate in the private sector and did not lead to an automatic expansion in money supply. It did so only to the extent government monetized the surplus by spending it domestically and the private sector balance of payments deficit did not offset this adequately. In the Muslim countries that have a balance of payment deficit, it is unhealthy monetary expansion along with public and private sector conspicuous consumption that generate the balance of payments disequilibrium through current account deficits and underground capital outflows. These can not be removed without socio-economic reform at a deeper level and healthy monetary and fiscal policies in the light of Islamic teachings.
INSTRUMENTS OF MONETARY POLICY:/tt/file_convert/551ee447497959d9398b4dfb/document.doc
To realize the objectives of monetary policy in an Islamic framework, the central bank in an Islamic economy may use the following instruments, jointly or separately, for regulation of money and credit.
i) TARGET GROWTH IN MONEY SUPPLY : The central bank should determine annually the growth desired in the money supply (M) in the light of national economic goals, including the desired but sustainable rate of economic growth and the stability in the value of money. This target growth in M should be reviewed quarterly, or as often as necessary, in the light of the performance of the economy and the trend of important variables. However, the targets should not be changed frequently but only when justified to accommodate economic shocks, both domestic and external.
ii) STATUTORY RESERVE REQUIREMENTS : Statutory Reserve Requirements against the commercial bank’s deposit liabilities usually consist of two parts : [a] Compulsory Cash Reserve Ratio (CRR), and [b] Liquidity Ratio (LR). Commercial banks may be required to deposit with the central bank in cash as CRR a certain proportion, say 5-10 percent, of their total deposits from the public. In addition, the banks may be required to keep with themselves shortly-maturing liquid assets, say 10-15 percent; against their deposits. These reserves serve the twin purpose of security and control of the banks’ capacity to create credit. Reserve requirements against demand deposits may be higher, while requirements against savings and Term (Mudaraba) deposits may be lower because of their equity nature, meant for investment by the banks and not supposed to be withdrawn frequently. The statutory reserve requirements may be varied by the central bank according to the dictates of monetary policy.
iii) CREDIT CEILINGS : It may be desirable to fix ceilings on commercial bank credit to ensure that total credit creation is consistent with monetary targets. Ins the allocation of this ceiling among individual commercial banks, appropriate care should be taken to ensure that it does not harm healthy competition among banks.
iv) ALLOCATION OF CREDIT : Since bank credit comes out of funds belonging to the public, it should be allocated that it helps to realize general social welfare. The criteria for its allocation, as for other Allah given resources, should be, first, the realization of the goals of the Islamic society, and, second, the maximization of private profit. This could be attained by ensuring that (a) credit allocation leads to an optimum production and distribution of goods and services needed by the majority of the society, and (b) the benefit of credit goes to an optimum number of businesses in society.
v) SELECTIVE CREDIT CONTROL : For example, central bank Mudaraba financing may not be made available except for specific purposes. The Central bank may also accept a relatively lower profit-sharing ratio, if considered necessary, for realizing the objective of distributing commercial bank financing to an optimum number of businesses for production of the goods and services which are most needed.
vi) MORAL SUASION : Moral suasion or persuasion should acquire an important place in Islamic central banking. The central banking. The central bank through its
personal contracts, consultations and meetings with the banks could achieve the desired goals.
vii) OTHER INSTRUMENTS : For proper functioning of the monetary and credit system and to secure its objectives and mandate the Islamic central bank may also use the following instruments to replace the Bank Rate or Discount Rate and control through regulation of interest rates:
1) Fixing a minimum and / or maximum ratio of profit for Islamic banks in their joint venture and Mudaraba activities. These ratios may vary for different fields of activity.
2) Designation of various fields for investment and partnership within the framework of the approved economic policies, and the fixing of a minimum prospective rate of profit for the various investment and partnership projects. The minimum prospective rate of profit may vary with respect to different branches of activity.
3) Fixing a minimum and maximum margin of profit, as a proportion to the cost price of the goods transacted, for banks in installment and hire-purchase transactions.
4) Determination of types and the minimum and maximum accounts of commissions for banking services.
5) Determination of the types, amounts, minimum and maximum bonuses, and the establishment of guidelines for advertisements by banks.
6) Determination of the minimum and maximum ratio in joint venture, Mudaraba investment, hire-purchase, installment transactions, buying or selling on credit, forward deals with respect to various fields of activity; and also fixing the maximum facility that can be granted to each customer.
FISCAL POLICY IN ISLAM
OBJECTIVES OF FISCAL POLICY IN ISLAM
a) Collection of sufficient revenue to meet Government revenue and development expenditures.
b) Ensuring maximum utilization of resources of the country;c) Economic well-being with full employment and optimum rate of economic growth.d) Maintaining stability in the value of money and price level.e) Attaining distributive justice.
INSTRUMENTS OF FISCAL POLICY IN ISLAM
1. Collection of Govt. Revenuea. Zakat Ushar and other compulsory paymentb. Taxes imposed by the Islamic Govt.c. Fees, penalties charged under Islamic laws.
2. Govt. Expenditurea. Revenue Expenditure by the Islamic Govt. and b. Development Expenditure by the Islamic Govt.c. Expenditure for eliminating povertyd. Expenditure for Islamic Dawah
Taxation : A comparison between an Islamic and a secular system.Sl. No. Limitations of Conventional System Superiority of Islamic System
1 Predominance of Indirect Tax Predominance of Direct Tax2. No control on imposition of taxes by the Govt. Limited and controlled tax by an
Islamic Govt.3. Huge corruption in the administration of taxes. No question of corruption in the
administration of taxes.4. Tax evasion is a common phenomenon Tax evasion is a rare phenomenon5. Payment of tax is not an Ebadah Payment of tax is an Ebadeh
Govt. Expenditure : A comparison between an Islamic and a secular system
Sl. No. Limitations of Conventional System Superiority of Islamic System1 Expenditure of the tax revenue is fully under the
control of the Govt.Expenditure of the tax revenue is not fully under the control of the Govt.
2. Exaggeration and corruption in Govt. Expenditure
No scope for exaggeration and corruption in Govt. Expenditure
3. Most of the expenditures are for elite class. Most of the expenditures are for meeting the basic need of the people.
Govt. Borrowing : A comparison between an Islamic and a secular system
Sl. No. Limitations of Conventional System Superiority of Islamic System1 Borrowing is based on interest Borrowing is Interest-free2. Borrowing is a regular policy matter Borrowing is last resort
ISLAMIC DEVELOPMENT BANK (IDB)ISLAMIC DEVELOPMENT BANK (IDB)
he Islamic Development Bank is an international financial institution established in pursuance of the declaration of intent issued by the Conference of Finance Ministers of Muslim Countries held
in Jeddah in Dhul Q’adah 1393H, corresponding to December 1973. The inaugural meeting of the Board of Governors took place in Rajab 1395H, corresponding to July 1975, and the Bank was formally opened on 15 Shawwal 1395H coresponding to 20 October 1975. The purpose of the Bank is to foster the economic development and social progress of member countries and Muslim communities in non-member countries individually as well as jointly in accordance with the principles of Shariah i.e. Islamic Law.
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The functions of the Bank are to participate in equity capital and to grant loans for productive projects and enterprises besides providing financial assistance to member countries in other forms for economic and social development. The Bank is also required to establish and operate special funds for specific purposes including a fund for assistance to Muslim communities in non-member countreis, in addition to setting up trust funds. The Bank is authorized to accept deposits and to mobilize financial resources through Shariah compatible modes. It is also charged with the responsibility of assisting in the promotion of foreign trade, especially in capital goods, among member countries; providing technical assistance to member countries; and extending training facilities for personnel engaged in development activities in member countries to conform to the Shariah.
The persent membership of the Bank consists of 53 countries. The basic condition of membership is that the prospective member country should be a member of the ‘Organization of the Islamic Conference’ OIC, pay its contribution to the capital of the Bank and be willing to accept such terms and conditions as may be decided upon by the IDB Board of Governors. Up to the end of 1412H (June 1992), the authorized capital of the Bank was two billion Islamic Dinars. Since Muharram 1413H (July 1992). in accordance with a Resolution of the Board of Governors, it became six billion Islamic Dinars, divided into 600,000 shares having a per value of 10,000 Islamic Dinars payable according to specific schedules and in freely convertible currency acceptable to the Bank.
THE OBJECTIVES OF ISLAMIC ECONOMICS THE OBJECTIVES OF ISLAMIC ECONOMICS
01. Definition of Economics
Prof. L. Robbins –“Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.
02. Definition of Islamic Economics
i) Islamic Economics is that branch of knowledge which helps realise human well-being through an allocation and distribution of scarce resource that is in conformity with Islamic teachings without unduly curbing individual freedom or creating continued macro-economic and ecological imbalances – Omar Chapra.
ii) Islamic Economics aims at the study of human falah achieved by organising the resources of the earth on the basis of co-operation and participants (Muhammad Akram Khan).
iii) Islamic Economics is the Muslim thinker’s response to the economic challengers of their times. In this endeavour they are aided by the Quran and the Sunnah as well as by reason and experience – M negatullahh Sidddiq.
iv) Islamic Economic is the sciences of how man uses resources and means of production to study his worldly needs according to a predetermined code given by Allah (SWT) in order to achieve the greatest equity-Princes Muhammad Al-Faisal Saud.
v) Islamic Economics is a social which studies the economic problem of the people imbued with the values of islam. It is a composite social science which studies the problem of production, distribution and consumption through integrative system of exchange and transfer overtime and their social through integrative system of exchange and transfer overtime and their social and moral consequences in the light of Islamic rationalism. It assumes the presence of Islamic man. M.A. Mannan.
03. Preliminaries :
i) There is a misconception in some sections that establishment of Islamic economy means establishment of Arab economy as it existed 1400 years back at the time of the Prophet (SM). This is not correct Islamic economy would be totally upto-date in its method of organization and use of technology. Only the principles and framework will be derived from the Quran, the teachings of the Prophet and the practices of the early days of Islam.
ii) Similarly, it is wrong to say that Islam does not give an economic system. We recognize capitalism as an economic system, though its basic characteristics are
only the recognition of the private right of ownership and freedom of economic activities for the individual. Likewise, socialism is treated as an economic system, even though its only basic characteristic is the social ownership of means of production. Islam gives us an much more comprehensive guidance in economic matters such as prohibition of interest compulsory levy of Zakat, freedom of work and enterprise, concern of the poor, distinction between the Halal (permissible) and Harm (prohibited) in income, consumption and production and so no. As such Islam undoubtedly gives mankind and economic system not found in other religions. An economic system does not mean only the details of organization, which are more or less the same in all economic systems.
iii) It is also necessary to bear in mind that an Islamic solution of the same problem may be more that one. There can be alternative solutions or models for the same problems or issues. The difference can be quite acute in such sectors as land reform and role of government is economy. As long as the alternative solutions proposed by Islamic scholars through Ijtihad had remained within the explicit framework of the Quran and the Sunnah, the alternatives should be considered Islamically valid and legitimate.
iv) The Islamic economy which established by the Prophet (SM) and developed by the Khulafa-i-Rashideen in Medina is the first model of Islamic economy in. so far as basic principles and values are concerned. This should always remain as a reference point along with the Quran and the Sunnah. We should remember that the Prophet freed the pre-Islamic Madinite economy from Jahiliya, or all un-Islamic practices. As such none can say that what was allowed in Madinite economy, at that time as not permissible today, or what was not permitted in that economy as permissible now.
04. The Goals of Islamic Economy :
The goals of an Islamic economy are as under :
(a) Establishment of Adl. (justice), to attain Hasanah (good) and Falah (welfare) in this life and the life hereafter.
(b) To establish Ihsan (gracious conduct or kindness) in economic affairs.
(c) Establishment of Maroof (proper or good acts practices institutions) in economic life.
(d) Elimination of Munker (evil, wrong or injurious practices from Economic life).
(e) Freeing humanity from un-wanted burdens and shackles and to make life easier for them.
(f) Ensure economic efficiency and accelerated rate of growth. Ensure maximum production & useful production.
(g) Maximize employment to ensure maximum distribution of wealth in Society.
i) Allah enjoins on you justice and gracious conduct (Sura Nahl : Ayat-90).
ii) When we give them power on earth, they establish prayer, give Zakat, enjoin Maroof and Prohibit Munkar (Sura : Hajj : Ayat : 41).
iii) He (the Prophet) enjoins them to follow right things and forbids them from evil, he makes pure things lawful for them and impure things unlawful, he relieves them of their burdens and frees them from shackles that bound them (Sura Araf Ayat : 157).
iv) Our lord, grant us good in this word and in the hereafter (Sura Baqara; Ayat:20).
v) We desired to show favour into those who were depressed in the earth, and to make them leaders and to make them inheritors and to establish them on earth (Sura Qasas, Ayat: (5-6)
vi) Co-operate in acts of piety and virtue and do not co-operate in acts of sin and transgression (of laws of God) (Sura Al-Maida, Ayat :2).
vii) So that wealth does not circulate only among rich people of you (Sura Hashr, Ayat :7)
There are many other verses of similar nature in the Holy Quran which clearly establish the aforementioned goals of Islamic economy.
viii) As regards achieving maximum economic growth, we can point out that Islam did not allow any owner to keep his agricultural land uncultivated for a long time. Islam also encouraged cultivation of barren land by any body who could do so. Hazrat Omar-bin Abdul Aziz directed his governors to lease all uncultivated state lands to any body who could cultivate against even one-tenth share of the crop. This indicates Islam’s concern for maximum utilization of resources for maximum economic growth. (Dr. Yusuf Al-Qaradawi: Al Halal, Wal Haram).
ix) Islam also encourages maximum distribution of wealth as has been indicated in the verse of Sura Hashr. Universal education has enjoined by the Prophet in his famous saying “Education is compulsory on all Muslims, male or Female”. Education helps gainful employment, which helps in better distribution of wealth. (S.N.H. Naqvi: Ethics and Economics. An Islamic Synthesis, First edition, Chapter-5, published by Islamic Foundation, U.K).
07. Basic Characteristics of Islamic Economy
i) Freedom of work and enterprise : Islam has allowed freedom of work and enterprise. This is evident from the Madinitc model of Islamic economy. A reading of the chapter of any Hadith collection in respect of agriculture, gardening, business etc. will establish this. The Quran also clearly states that “Allah has made business lawful for you (Sura Baqara, Ayat -275)”
ii) Free Economy : Islam allows economy to cooperate freely according to the market forces subject to Islamic restrictions and guidelines on production. Distribution, marketing, investment trade, exchange, wages etc. The state can also further interfere in this free economy to restore equilibrium and establish justice and other Islamic objectives as explained above. In an Islamic economy, there is an “allowability constraint” in every idle (a terms introduced by Dr. S.N.H Naqvi in his above mentioned book). An
entrepreneur can produce only permitted things, Profit should be normal in such an economy after giving proper wages to the labourers in accordance with Islamic principles. Some forms of trade practices, exchange, investment and land tenancy in agriculture are prohibited in Islam. It also disallows monopoly and hoarding as social evils. The aforesaid restrictions make free economy in Islam qualitatively different form capitalism. Islam can not be said to be capitalistic only because it allows forces of demand and supply are fundamental economic forces, which were operational in all ages even before capitalism.
iii) Trusteeship ownership : In Islam God is the true owner of all things. The Quran says: “To Allah belongs whatever is in the earth”. (Al-Imran). However, Allah in His mercy allows human beings to inherit wealth, own it and use it subject to His laws as evident from the following verses :
a) The land belongs to Allah. He allows it to be inherited by won so even he pleases. ( Sura Araf, Ayat : 128).
b) Do they not see that we have created for them ---- among the things fashioned by us ---- cattle of which they become owners? (Sura Yasin, Ayat : 29). Islam, therefore, allows man as Vice-grant, to inherit from Allah (that is to own) wealth. This is indeed a truss’ for proper use.
iv) Kinds of Ownership : In early Islam there were three kinds of ownership: Private, communal a state ownership. The books of Hadith are full of accounts of individual ownership. This was the standard ownership. Some important things like water, canals pastures and graveyards were communal properties. The state owned the mines, rivers and large tracts of land . After the conquest of Syria and Iraq, these lands were made state lands and were not allowed to go into private ownership. (Tafhimul Quran, Sura Hashr, Syed Abul Ala Maududi)
v) State Ownership : There is no bar on state ownership of enterprise in Islam. The basic economic institutions can be or should be brought under state control, if required to establish social justice or protect the interests of the community.
vi) Protection of lawful Property : Islam protects lawful property and is in favour of confiscation of unlawful property. There are many instances of take over of unlawful property during the period of Hazrat Omar and Hazrat Omar bin –Abdul Aziz. Lawful property can be taken over by the state only for valid social reasons after due compensation. During the last Hajj the Prophet (SM) announced the principle of protection of lawful property. The Quran says, “ don’t eat each other’s property wrongly” (Sura Nisa, Ayat -29).
vii) Prohibiting of Interest : Islam prohibits interest. This requires a total reorganization of the economy, banking, investment, exchange, business and international trade. A big effort is under way in the Muslim world in this direction. A body of literature has already come up on this subject.
viii) Zakat : Islam has made Zakat compulsory on the wealth of rich Muslims. This is spent for the weaker and distressed sections of the society. Zakat not only distributes wealth between the rich and the poor of the society, it also influences investment, savings and allocation of income and resources. A detailed study has been made in this regard by Dr. Monzer Kahf in his book “Islamic Economy” American Trust Publications, USA, A rich body of literature has come up in recent times on Zakat. The Zakat and Ushr ordinance of Pakistan can be particularly referred to in this connection.
ix) Concern for Poor : This is a special feature of Islam. Zakat is one institution which testifies to this. In this connection we may refer to ayat 5-6 Sura Qausar as quoted in para 6 above, is particularly significant, where Allah, the Almighty has expressed this desire to show favour on the depressed people, Islamic economy shall establish all possible institutions to carry out this desire of the Almighty.
x) Distribution of inheritance : Islam has not left the distribution of inheritance on the whoms of a person, In Islam a person can not favour one over the other of his relations for temporary or subjective reasons as is the rule in the West. Islam distributes inheritable property among several groups of people.
a) Children
b) Husband / Wife
c) Parents
d) Brothers and sisters in certain situations.
This distribution has taken care of different groups keeping in view their social role, requirements proximity of kinship relationships. For those who remain outside the list of inheritors. Islam has provided for wasiat (will) for all such relations if they are in a distressed condition. A person can will upto one 3rd of his property for distressed relations or others outside the inheritors.
Time and again as we were from the clear injunctions of Allah, we hark back discouraged and crest fallen. Islam provides us the principles of social behavior in our economic life. It is upto us to develop the technology for the implementation of such principles. Already there is a resurgence over the Islamic World towards these ends. We pray to Allah for his blessings and continued guidance. (Summary of speeches given in Islamic Banking course held in BIBM in January, 1982).
A financial system that is based on Islamic principles and values, which eliminates Riba and ensure a profit sharing mechanism in the financial system may be called IFS. It may be characterised by the absence of interest based financial institution & transactions, doubtful transactions or gharar, Stocks of companies dealing in unlawful activities, unethical or immoral transactions such as market manipulation, insider trading short-selling etc.
02. DIFFERENCES BETWEEN CFS & IFS
The conventional financial system of two types.
Socialistic financial system and 2) capitalistic financial system both systems have been proved inefficient to establish economic balance in the society.
Basis of Differences CFS IFS1. Religious Belief Secular & separates Religion
from other Parts human like.Belief in unity of God & relates this belief to economic Life of a man.
2. Freedom of Economic activity
In socialism govt enjoys economic freedom but in capitalism Individuals enjoys freedom.
Restrictive freedom is allowed in the light of Shariah both by the Govt & /or individuals.
3. Ownership of means Socialism-state Ownership Capitalism-individual Ownership
Allah is the exclusive owner. Man is the caretaker of the property
4. Goals of financial System Socialism-profit of the society Capitalism-Individuals profit.
12. Lender or Bank’s expectation in terms of dept financing.
Interest Profit or loss sharing
13. Modes of Investment Loan, Overdraft & Cash credit.
Mudarabah, Musharaka, Murabaha etc.
03. PRINCIPLES OF AN ISLAMIC FINANCIAL SYSTEM
The basic framework for an Islamic financial system is a set of rules and laws, collectively referred to as shariah, governing economic, social, political and cultural aspects of Islamic societies. Shariah originates from the rules dictated by the Quran and its practices, and explanations rendered (more commonly known as Sunnah) by the Prophet Muhammad. Further elaboration of the rules is provided by scholars in Islamic jurisprudence within the framework of the Quran and Sunnah. The basic principles of an Islamic financial system can be summarized as follows :
Prohibition of interest : Prohibition of riba, a term literally meaning “an excess”
and interpreted as “any unjustifiable increase of capital whether in loans or sales” is the central tenet of the system. More precisely, any positive, fixed, predetermined rate tied to the maturity and the amount of principal (i.e., guaranteed regardless of the performance of the investment) is considered riba and is prohibited. The general consensus among Islamic scholars is that riba covers not only usuary but also the charging of “interest” as widely practiced.
This prohibition is based on arguments of social justice, equality, and property rights. Islam encourages the earning of profits but forbids the charging of interest because profits, determined ex post, symbolize successful entrepreneurship and creation of additional wealth whereas interest, determined ex ante, is a cost that is accrued irrespective off the outcome of business operations and may not create wealth if there are business losses. Social justice demands that borrowers and lenders share rewards s well as losses in an equitable fashion and that the process of wealth accumulation and distribution in the economy be fair and representative of true productivity.
Risk sharing. Because interest is prohibited, suppliers of funds become investors
instead of creditors. The provider of financial capital and the entrepreneur share business risks in return for shares of the profits.
Money as “potential” capital. Money is treated as “Potential” capital –that is, it
becomes actual capital only when it joins hands with other resources to undertake a productive activity. Islam recognizes the time value of money, but only when it acts as capital, not when it is “potential” capital.
Prohibition of speculative behavior. An Islamic financial system
discourages hoarding and prohibits transactions featuring extreme uncertainties, gambling, and risks.
Sanctity of contracts. Islam upholds contractual obligations and the disclosure of
information as a sacred duty. This feature is intended to reduce the risk of asymmetric information and moral hazard.
Shariah approved activities. Only those business activities that do not violate
the rules of shariah qualify for investment. For example, any investment in businesses dealing with alcohol, gambling, and casinos would be prohibited.
1. The Bank and the client purchase the asset jointly with specified equity sharing the ownership under HPSM contract.
2. Though ownership is joint, asset may be registered in the name of any one mentioning in the HPSM agreement.
3. Rent cannot be considered as price or part of price of the Asset.
4. In the HPSM agreement Hiree does not sell or Hirer does not purchase the asset but they promise to sell and purchase the same part by part only.
5. The hire contract become effective from the day on which the Hiree transfer the possession of the asset in good order and assemble condition to the Hirer.
6. As the portion of the Bank is sold and transferred part-by-part the rent will be reduced proportionally.
7. Under HPSM agreement bank will act as partner, Hiree and at last as a seller and client will act as partner, as a hirer and lastly as purchaser. The sale and purchase will be effected by a separate sale contract.
8. Ownership risk will be borne by both the parties proportionally. The Hirer will maintain the asset with due prudence and shall not be held responsible for the damage or destruction of the asset without transgression, default or negligence, otherwise he must be responsible for the same.
9. The Hirer is responsible for keeping the asset in goods condition as a trustee.
10. The Hirer cannot change or remove the property without the permission of the Hiree.
RULES OF HPSM
Ownership of the asset of both the Hiree and the Hirer should be recognized as per law of the land.
The asset(s) to be hired must not be a fungible one (Perishable or consumable).
The asset(s) and the benefit/service drived from it is within the category of ‘Halal’ or at least ‘Mobah’ as per Islamic Shariah.
The Hiree is under obligation to enable the Hirer to the benefit from the asset(s) by putting the possession of the asset(s) at his disposal in useable condtion at the commencement of the hire period.
In a hire contract, the period of hire and the rental to be paid per unit of time be clearly stated.
It is a condition that the rental falls due from the date of handing over of the asset to Hirer and not from the date of contract or use of the asset.
It is permissible to advance, defer or install the rental in accordance with the Agreement.
The hired assest is a trust in the hands of the Hirer. He will maintain the asset(s) with due produce and shall not be held responsible for the damage or destruction of the asset without transression, default or negligence; otherwise he must be responsible for the same.
The Hiree/owner bears all the basic costs for repairs & maintenance as per contract.
The Hirer bears the cost of ordinary routine maintenance.
The hire contract is binding and no one party shall unilaterally reseined except reasons that abrogate binding contract such as damage or destruction.
If the hired asset is damaged or destructed by the act of Allah and if the Hiree offers a substitute with the same specifications agreed upon in the hire contract the contract does not terminate.
It is also permissible to sell the hired asset by the Hiree to the Hirer during the tenure of the hire period either part by part or in full at a time.
GESTATION PERIOD
The period from the date of 1st disbursement for acquisition of the asset/property to the date of handing over of the asset/property to the Hirer in good order and useable condition to derive the desired service (s)/benefit(s) is called “Gestation/Interim period”.
During the gestation period, the asset remains under construction /installation/making form, so the asset can not yeild the desired services/benefit(s) and as such no rent should be charged for that period.
Taking the cost, utility, value addition, market demand for the asset, the sale Price of the Bank’s share of the asset/property may be fixed at a higher Level to cover the cost/benefit of the “Gestation Period” or in other words, the Bank may sell its share in the asset at a higher price with mutual consent of the Bank and the purchaser.
CALCULATION OF MONTHLY INSTALLMENT
Calculation of monthly installment for the Investment allowed under HPSM mode (or Investment allowed against payment in installment basis).
Total Rent/Profit = (P +Pi)/2 x RR x N + G
Where, P = Amount Disbursed / To be disbursedPi = Principal InstallmentRR = Rate of ReturnN = Total period of Investment (excluding
gestation period).G = Un earned Rent / Profit for gestation period.
Monthly Installment = Monthly Principal + Average Monthly Rent
I = Principal + Monthly InstallmentR = Rate of Return
Rent of the gestation period is to be calculated also & spreaded over the whole period of the investment and to be added up with the monthly installments.
Monthly Installment = Monthly Principal + Average Monthly Rent
2400 = 12 months x 2 (reducing balance method) x 100 (Percnetage) ** Plus rent of the gestation period considering higher asset value.
Problem :
Suppose an HPSM Investment of Tk. 5,00,000/- was allowed to a client for a period of 5 years excluding gestation period of 1 year at 15% RR.
What will be the monthly installment ?Calculation :Principal (P) = Tk. 5,00,000/=Principal Installment (Pi) = Tk. 5,00,000/- 60 = 8,333/-Rate of Return (RR) = 15%Period of Investment (No. of years) = 5Un Earned Rent/Profit for gestation period (G) = 75,000/-
Total Rent / Profit = (P + Pi)/2xRRxN + G= (5,00,000+8,333)/2 x 15% x 5 + 75,000= 2,54,166.50 x 15% x 5 + 75,000= 2,65,624.87
1. No rent on rent2. Rent of the gestation period is not recovered during the said period.3. Presession of the asset is being handed over to the client.
It has nothing to do with interest ?It is the expression of service equaty.
