Chapter 1: Banking System PDF

Chapter 1: Banking Banking System MBFB 2043 Islamic Banking and Financial Services Dr. Wan Shahdila Shah Bt Shahar Introduction to Islamic Islamic Banking Islamic banking is a system of banking and finance that adheres to Islamic principles and is based on the concept of risk sharing and profit s...

Chapter 1: Banking Banking System MBFB 2043 Islamic Banking and Financial Services Dr. Wan Shahdila Shah Bt Shahar Introduction to Islamic Islamic Banking Islamic banking is a system of banking and finance that adheres to Islamic principles and is based on the concept of risk sharing and profit sharing. It prohibits the payment or receipt of interest, known as "riba" in Arabic, uncertainty, known as "gharar" and gambling, known as "maysir". Historical Evolution of of the Islamic Financial Financial System The Islamic financial system (IFS) traces its roots back to the time of Prophet Muhammad Muhammad SAW, about 1,400 years ago. This system has evolved over centuries, adapting centuries, adapting to changing needs while staying true to Islamic principles. Today, Today, modern Islamic finance combines traditional values with innovative financial financial products to serve Muslims and non-Muslims alike around the world. The First Century of Islamic Finance Foundations in the Qur'an and Sunnah 1 The doctrine of financial operations was derived derived directly from the Holy Qur'an and the Sunnah 2 Prophet Muhammad's Financial Sunnah (traditions) of Prophet Muhammad (p.b.u.h.). Practices (p.b.u.h.). These sacred texts provided the During Prophet Muhammad's lifetime, Islamic fundamental principles for Islamic finance. methods of finance often drew upon examples from from the Prophet's experiences. There are many many narrations about the Prophet Muhammad SAW Early Islamic Contracts 3 Muhammad SAW buying on credit, taking financing Prophet Muhammad SAW used the mudarabah financing and sometimes giving personal property as a mudarabah contract to trade with Khadijah's capital property as a security or lien. capital which involved the Prophet SAW travelling to travelling to Syria. He also engaged in musyarakah musyarakah partnerships and encouraged benevolent Evolution with the Spread of Islam Geographical Expansion After the demise of Prophet Muhammad SAW in 630 CE, Islam began to spread rapidly rapidly reaching North Africa, Spain in Europe, and a large part of Asia. Juristic Reasoning The changing needs of the people and the increasing Islamic geographical boundaries required that the teachings of the Quran and Sunnah be expanded through juristic reasoning (Ijtihad) to solve commercial and business problems of the people. Contract Improvements During this period, existing contracts were improved. Modern day IFIs have introduced various introduced various Shariah-compliant products, for instance: Majallat al-Ahkam al-'Adliyyah al-'Adliyyah and Partnership (Sharikah). Historical Development of Islamic Banking Banking The roots of Islamic banking can be traced back to the early days of Islam, with early Muslim traders and merchants and merchants developing innovative methods of financing and trade that were free from interest. 1 Early Islamic Era The concept of risk sharing and profit sharing was practiced by early Muslim traders, laying the laying the foundation for Islamic banking principles. 2 Modern Era The modern Islamic banking system emerged in the mid-20th century, with the establishment of the first Islamic banks in Egypt and Sudan. 3 Global Growth Islamic banking has experienced significant growth in recent decades, with the establishment of establishment of Islamic banks and financial institutions in numerous countries around the world. the world. Modern-Day Islamic Finance Resurgence Factors Private Initiatives Global Spread The growth of modern Islamic banking Islamic finance was introduced in the From the 1960s onwards, Islamic banking can be attributed to three the early stages by purely private and financial institutions began to emerge factors: and individual initiatives. This grassroots emerge around the world, from Egypt grassroots approach helped establish the Egypt and Malaysia to Switzerland and 1. The rise of oil prices after 1974 establish the foundation for the modern and the United States, demonstrating 2. Devout Muslims' desire for a financial modern Islamic financial system. demonstrating the global appeal and financial system based on Islamic and adaptability of Islamic finance principles principles. 3. The belief that rediscovering Islamic values was the best response to rapid industrialization and urbanization in post-colonial countries Comparison of Islamic and Conventional Banking Islamic and conventional banking systems differ in their core principles, products, and practices, reflecting their distinct approaches to finance and investment. Principle Islamic Banking Conventional Banking Interest (Riba) Forbidden Allowed Investment Ethical and socially responsible May include investments in industries considered haram in Islam Profit Sharing Common practice Not a primary principle Risk Sharing Emphasis on risk sharing Less emphasis on risk sharing between banks and customers Different Practices in the Formation of of IFIs 1 Full-fledged Islamic Banks These can be newly established institutions or conventional banks that have fully converted to Islamic banking principles. 2 Islamic Banking Windows Conventional banks offer Islamic banking services from the same branches, with strict segregation of funds and operations. 3 Islamic Banking Subsidiaries These are either newly established or converted from existing Islamic windows of conventional banks. conventional banks. 4 Conversion Approaches Banks can choose between comprehensive and immediate conversion or a gradual, step-by-step by-step approach to becoming fully Shariah-compliant. Conversion from Conventional to Islamic Banking The conversion of conventional banks to Islamic banks can take different approaches, ranging from comprehensive and immediate changes to organic growth following a step-by-step process. This presentation will explore the various models and considerations for transitioning to Islamic banking, with a focus on Malaysia's dual banking system. Window-Based Islamic Banking Model Cost Savings Window-based Islamic banking can provide cost savings and other advantages for conventional banks looking to offer Islamic products. Shariah Compliance Concerns An overriding concern is that the Shariah-compliant and non-compliant funds could become mixed. become mixed. Regulatory Requirements Authorities impose firewall requirements including segregation of funds, separate branches, and separate branches, and separate accounting systems. IFSB Core Principles The International Financial Services Board requires internal systems and controls to ensure Shariah Shariah compliance, proper risk management, and adequate disclosures for Islamic windows. windows. Malaysian Experience on Dual Banking System Malaysia has a dual banking system, with both conventional and Islamic banks operating side-by-side, allowing for a diverse range of financial services. Islamic Banking Conventional Banking The Islamic banking sector in Malaysia has grown rapidly, with Conventional banks in Malaysia offer a wide range of financial numerous Islamic banks and financial institutions providing a financial products and services, including loans, deposits, and comprehensive range of products and services. and investments. 1. Traditional banking practices and principles 1. Sharia-compliant products and services 2. Strong presence in the Malaysian financial market 2. Focus on ethical and socially responsible investments 3. A well-established and regulated sector 3. Growing importance in the Malaysian economy Malaysia's Dual Banking System 1967 1 Establishment of Lembaga Tabung Haji (Muslim Pilgrimage Fund Board) to collect deposits from from pilgrims and provide Shariah-compliant savings 2 1983 savings management. Incorporation of the first Islamic bank in Malaysia, Bank Islam Malaysia Berhad (BIMB). 1993 3 Launching of Interest-free Banking Scheme (IFBS) (IFBS) allowing conventional banks to offer Islamic Islamic banking products and services. 4 1994 Establishment of the Islamic Interbank Money Market Market (IIMM) as a platform for short-term 2002 5 investment based on Shariah principles. Call from Bank Negara Malaysia for most Islamic Islamic windows to be converted to Islamic subsidiaries. Supporting Infrastructure for Islamic Finance in Malaysia 1 Regulatory Framework A robust regulatory and supervisory framework, reinforced by legal and Shariah frameworks, is crucial frameworks, is crucial for the stability and growth of the Islamic finance sector. 2 Payment Systems Advanced payment and settlement systems are essential to facilitate efficient and secure Islamic Islamic financial transactions. 3 Talent Development Developing a pool of qualified professionals with expertise in Islamic finance is critical for the the industry's long-term sustainability and success. Malaysia's Approach to Developing the Islamic Financial Industry 1 Phase I: 1980s Establish foundation. Promote financial inclusion for Muslim. Provide alternative solution. 2 Phase II: 1990s Upgrade institutions. Broaden range of solutions beyond the Muslim community. Generate activity and stimulate competition. 3 Phase III: 2000s Strengthen Islamic financial landscape. Address ecosystem gaps and global expansion Achieve scale, enhance capacity and widen solutions.  Development of the Islamic Finance Industry Malaysia (cont...) ❑ Some key Initiatives The Central Bank of Malaysia Act (CBA) 2009 Establishment of SAC-BNM in 1997 MoU with the Dubai Financial Services Authority to promote effective supervision of financial institutions operating in both countries in 2018. Introducing VBI in 2017 Establishment of International Centre for Education in Islamic Finance (INCEIF) in 2005 Establishment of International Shari'ah Research Academy for Islamic Finance (ISRA) in 2008 Establishment of ISRA International Consulting Sdn Bhd in 2012 Establishment of Association of Shariah Advisors in Islamic Finance in2011 Establishment of Chartered Institute of Islamic Finance Professionals in 2015 © INCEIF University 2023 16 Milestones of Islamic Finance in Malaysia This presentation will explore the significant milestones in the development of Islamic finance in Malaysia, highlighting key events and institutions that have shaped this sector. Milestones of Islamic Finance in Malaysia 1 1983: Islamic Banking Act, 1983 The Islamic Banking Act, 1983, laid the foundation for the development of Islamic banking in Malaysia. It provided the legal framework for the establishment of Islamic banks and the issuance of Shariah-compliant financial products. 2 1983: Establishment of the first Islamic bank (Bank Islam Malaysia Berhad) The establishment of Bank Islam Malaysia Berhad in 1983 marked a significant milestone in the development of Islamic banking in Malaysia. It was the first dedicated Islamic bank in the country, offering a range of Shariah- compliant banking products and services. 3 1984: Takaful Act, 1984 The Takaful Act, 1984, established the legal framework for the development of Takaful, a Shariah-compliant insurance system, in Malaysia. It provided the regulatory guidelines for the establishment of Takaful operators and the issuance of Takaful products. 4 1984: Establishment of the first takaful operator (Syarikat Takaful Malaysia Berhad) Berhad) The establishment of Syarikat Takaful Malaysia Berhad in 1984 marked the beginning of Takaful operations in Malaysia. It was the first Takaful operator in the country, offering a range of Shariah-compliant insurance products. Creating Impact Through Islamic Finance BNM aims to enhance Islamic finance's role in supporting socio- economic development, aligned with the United Nations Sustainable Development Goals (SDGs), and drive societal impact through Value- Based Intermediation (VBI). Value-Based Intermediation (VBI) in in Islamic Finance Introduction of VBI In July 2017, Bank Negara Malaysia introduces the concept of Value-Based Intermediation Intermediation Strategy Paper In March 2018, BNM collaborates with the Islamic finance industry to issue a strategy on VBI strategy on VBI VBI Definition VBI aims to deliver Shariah outcomes through practices that generate positive and sustainable sustainable impact on the economy, community, and environment Broader Impact VBI transcends wealth protection to encompass other essentials like protection of religion, life, religion, life, intellect, progeny and wealth Tripartite Linkage between Maqasid, VBI, TBL and 15 of SDGs Tripartite Linkage Maqasid 1 The five objectives of Islamic Law VBI 2 Value-Based Intermediation TBL 3 Triple Bottom Line 15 of SDG 4 United Nations Sustainable Development Goals Ethical and Socially Responsible Aspects of Islamic Banking Islamic banking operates on a foundation of ethical principles, promoting social responsibility and contributing to the well-being of society. Environmental Responsibility Social Justice Islamic banks are encouraged to invest in sustainable Islamic banks prioritize financial inclusion and access to sustainable businesses and projects that have a positive to financial services for marginalized communities, positive impact on the environment. promoting social equality. Charitable Giving Economic Development Islamic banks support charitable causes and contribute to Islamic banks play a role in promoting economic the welfare of the community by donating to Islamic development by investing in businesses and projects that charities and organizations. contribute to job creation and growth. Human Capital Development in Islamic Finance Higher Education Research Institutions like INCEIF offer specialized Islamic finance education ISRA conducts advanced research in Islamic finance education Training Advisory Services IBFIM provides professional training in Islamic banking and Organizations like ISRA Consulting offer expert advisory services and finance services Malaysia's human capital development landscape for Islamic finance is extensive and comprehensive, covering higher education, education, research, training, and advisory services that are globally acknowledged for their quality and sophistication. Key institutions Key institutions include the International Centre for Education in Islamic Finance (INCEIF), International Shariah Research Academy for Research Academy for Islamic Finance (ISRA), ISRA International Consulting Sdn Bhd, Islamic Banking and Finance Institute Malaysia Institute Malaysia (IBFIM), Association of Shariah Advisors in Islamic Finance, and Chartered Institute of Islamic Finance Professionals. Professionals. The Growth of Islamic Banking Globally Islamic banking has witnessed phenomenal growth in recent decades, expanding its reach across the globe, with increasing with increasing numbers of Islamic banks and financial institutions. 1 Geographical Expansion 2 Product Innovation Islamic banking has expanded to numerous Islamic banks are continually developing and countries across the globe, from Asia and the innovating new products and services to meet the Middle East to Africa and Europe, reaching a diverse needs of their customers, including retail broader customer base. and corporate banking. 3 Regulatory Frameworks 4 Increased Investment Governments and regulatory authorities in various There has been a significant increase in investment various countries have established frameworks to investment in the Islamic banking sector, driven by frameworks to support the growth and driven by the demand for ethical and Sharia- development of the Islamic banking industry. compliant financial solutions. industry. Fintech and Innovation in Islamic Finance Fintech is transforming the Islamic finance landscape, with innovative technologies and platforms enabling the development of new products, services, and business models. Digital Banking Blockchain Technology Digital banking platforms are offering Islamic financial services through mobile Blockchain technology is being explored to improve efficiency and security in through mobile apps and online interfaces, providing greater convenience and security in Islamic finance, enhancing transparency and trust in financial convenience and accessibility. financial transactions. Future Trends and Outlook for Islamic Banking Islamic banking is poised for continued growth and expansion, driven by factors such as increasing awareness of Islamic principles, technological advancements, and growing demand for ethical financial solutions. 1 Global Expansion 2 Technological Innovation Islamic banking is expected to expand into new Fintech and digital innovations will continue to play a new markets and reach a wider customer base, as its key role in shaping the future of Islamic banking, base, as its principles gain broader acceptance. driving efficiency and customer experience. acceptance. 3 Product Diversification 4 Regulatory Support Islamic banks are expected to offer a wider range of Governments and regulatory bodies are likely to range of products and services to meet the diverse to continue supporting the growth of Islamic banking diverse needs of individuals, businesses, and banking by providing clear frameworks and governments. guidelines.