Unit 5 - Introduction to Islamic Banking PDF

UNIT 5 Introduction to Islamic Banking Victor Ian C. Zoleta, CFIMS, CTP, MBA  OUTLINE of DISCUSSION 5.1 Principles of Islamic Banking a) Overview: Terminologies and Practices b) Islamic Banking vs. Conventional Banking 5.2 Historical Developments in the Philippines a) Al...

UNIT 5 Introduction to Islamic Banking Victor Ian C. Zoleta, CFIMS, CTP, MBA  OUTLINE of DISCUSSION 5.1 Principles of Islamic Banking a) Overview: Terminologies and Practices b) Islamic Banking vs. Conventional Banking 5.2 Historical Developments in the Philippines a) Al Amanah Islamic Investment Bank of the Philippines (AAIIBP) b) BSP Circulars on Islamic Banks (IBs) and Islamic Banking Units (IBUs)  Islamic Banking Islamic Finance or Shari’ah-compliant finance. Islamic banking is grounded in the tenets of the Islamic faith as they relate to commercial transactions. Financial services and activities in accordance with Shari’ah Islamic law, principles and rules. Islamic Banking Business: refers to banking business with objectives and operations that do not involve riba (interest) as prohibited by Shari’ah and which conducts its business transactions in accordance with the principles of Shari’ah. Source: Asian Development Bank, Bangko Sentral ng Pilipinas, Corporate Finance Institute, International Monetary Fund, Investopedia.  Islamic Banking Shari’ah : the practical divine law deduced from its legitimate sources: Qur’an, Sunnah, consensus of Muslim scholars (Ijma), analogical deduction (Qiyas) and other approved sources of Islamic law. It does not permit receipt and payment of riba, gharar (excessive uncertainty), maysir (gambling), short sales or financing activities that it considers harmful to society. Instead, parties must share the risks and rewards of a business transaction and the transaction should have a real economic purpose without undue speculation, and not involve any exploitation of either party. Quran: central religious text of Islam; derived from the principles of Islamic banking. All transactions must comply with Shari’ah, the legal code of Islam based on the teachings of the Quran. Fiqh al-muamalat : rules that govern commercial transactions in Islamic banking. Source: Asian Development Bank, Bangko Sentral ng Pilipinas, International Monetary Fund..  How does Islamic Banking work? Fundamental principles:  Sharing of profit and loss.  Prohibition of the collection and payment of interest (riba) by lenders and investors. Money must be used in Shari’ah-compliant activities to generate profits. Partnership (Mudarabah) Trade (Murabahah) Lease (Ijarah) Equity Participation Image Source from the Internet Source: Bangko Sentral ng Pilipinas.  How does Islamic Banking work? EQUITY PARTICIPATION Requires a borrower to give the bank a share in their profits rather than paying interest. (similar to profit sharing). If a bank loans money to a business, the business will pay back the loan without interest and instead give the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit. Source: Bangko Sentral ng Pilipinas, Corporate Finance Institute, Investopedia.  Islamic Banking Terminologies TERM DEFINITION Gharar Uncertainty Halal Activities/items that are lawful or permitted under Shari’ah. Haram Activities/items that are unlawful or forbidden under Shari’ah. A binding contract of lease where the usufruct of an asset Ijarah Financing owned by the lessor is sold to the lessee against the payment (Operating Lease) of a specified amount of rent for a specified period. A form of lease contract where the lessee (i.e. client) has an option to own the asset at the end of the lease period either through: Ijarah Muntahia a) Sales contract for the purchase of the asset for a token Bittamleek consideration or payment of the market value. (Finance Lease) b) Gift contract Source: Bangko Sentral ng Pilipinas. (n.d.). Islamic Finance Terms. https://www.bsp.gov.ph/Pages/FinancialStability/Islamic%20Banking/Islamic_Banking.aspx  Islamic Banking Terminologies TERM DEFINITION Islamic Banking Unit Refers to a division, department, office or branch of a conventional bank that conducts business in accordance with the principles of Shari’ah. Kafala Personal guarantee granted by a third party (guarantor) in favor of a creditor guaranteeing the debt of a debtor. Maysir Gambling Mudarabah A contract between the capital provider or rab-al-maal (i.e. IB / IBU) and (Silent Partnership) an entrepreneur or mudarib. (i.e. client) Profits are shared in agreed ratio while losses are to be borne solely by the rab-al-maal unless the losses are due to the mudarib’s misconduct or breach of contract. Murabahah Financing Refers to an agreement where the IB/IBU buys a specified asset and (Cost-plus Financing) subsequently sells that asset to a client at cost plus an agreed profit margin. Source: Bangko Sentral ng Pilipinas. (n.d.). Islamic Finance Terms. https://www.bsp.gov.ph/Pages/FinancialStability/Islamic%20Banking/Islamic_Banking.aspx  Islamic Banking Terminologies TERM DEFINITION Partnership contract between IB/IBU and customer to contribute capital to an enterprise. Musharakah Financing Profits generated by that enterprise or real estate/asset are shared (Profit/Loss Sharing) in accordance with the terms of the musharakah agreement while losses are shared in proportion to each partner’s contribution. Qard The recipient has the obligation to return the exact initial loan value (Loan) by the end of the contract term. A contract under which one party (pledgor) charges an asset in Rahn favor of the second party (pledgee) in order to guarantee the (Pledge Contract) repayment of a debt in case of debtor’s failure or default in payment. Riba The receipt and payment of interest imposed/charged on various (Interest) types of lending and borrowing. Source: Bangko Sentral ng Pilipinas. (n.d.). Islamic Finance Terms. https://www.bsp.gov.ph/Pages/FinancialStability/Islamic%20Banking/Islamic_Banking.aspx  Islamic Banking Terminologies TERM DEFINITION Set of rules and principles governing the overall Islamic financial Shari’ah system. Refers to certificates of equal value representing undivided shares in Sukuk ownership of tangible assets, usufructs, and services or assets that are (Islamic Bonds) undertaken in accordance with Shari’ah principles. Mutual guarantee for the commitment to donate a specified Takaful contribution to the participants’ risk fund whereby a group of (Islamic Insurance) participants agree to support one another for losses arising from risks. An agreement wherein one party known as the principal authorizes Wakala another party known as agent or wakil to perform a particular task, as (Agency Contract) may be delegated by principal, with or without imposition of fee. Muslim’s annual religious obligation of almsgiving for charitable Zakat Payable purposes. Source: Bangko Sentral ng Pilipinas. (n.d.). Islamic Finance Terms. https://www.bsp.gov.ph/Pages/FinancialStability/Islamic%20Banking/Islamic_Banking.aspx  Debt Instrument vs. Sukuk Differences DEBT INSTRUMENT SUKUK Description Proof of debt Proof of ownership Source of Income Interest Profit from business undertaking Compliant with Shari’ah, Compliant with domestic laws Eligibility of Assets domestic law, regulations, as and regulations, as applicable. applicable. For Shari’ah-compliant projects, General government budget, assets, services, activities only, Purpose financing and/or other which may also include development purpose. government financing and/or other development purpose. Source: Bangko Sentral ng Pilipinas  Islamic Banking vs. Conventional Banking ISLAMIC BANKING CONVENTIONAL BANKING Depositors are investors rather than Depositors are lenders. lenders. Bank pays fixed interest on deposit Risk sharing through profit and loss liabilities and charges interest on sharing. loans. Bank prefers assets and liabilities Bank is exposed to assets and are matched. liabilities mismatch risk. Money is a product besides a Real Asset is a product; Money is medium of exchange and a store of just a medium of exchange. value.  Islamic Banking vs. Conventional Banking ISLAMIC BANKING CONVENTIONAL BANKING Profit on the exchange of goods & Time value is the basis for charging services is the basis for earning interest on capital. profit. Interest is charged even in the case, Loss is shared when the the organization suffers losses. Thus organization suffers a loss. no concept of sharing loss. Due to the failure of the project, the Due to the failure of the projects the management of the organization can loan is written off as it becomes a be taken over to hand over to better nonperforming loan. management.  Islamic Banking in the Philippines Promoting an inclusive and participative banking community for every Filipino. The Bangko Sentral ng Pilipinas (BSP) supports the development of Islamic banking and finance in the country. Goal of financial inclusion of all Filipinos. Serves everyone - granting Muslims much-needed access to financial services and providing non-Muslims with alternative banking and finance options.  Development of Islamic Banking in the Philippines AL AMANAH ISLAMIC INVESTMENT BANK IN THE PHILIPPINES YEAR DESCRIPTION Enactment of Presidential Decree No. 264: Creation of the Philippine Amanah Bank – the first 1973 Islamic Bank in the Philippines. Enactment of Presidential Decree No. 542 (as amended by PD No. 264; aligned Al Amanah Bank’s 1974 functions with Islamic beliefs and principles). Ratification of Republic Act No. 6848 (The Charter of Al-Amanah Islamic Investment Bank of the 1990 Philippines – made AAIIBP a universal bank, allowing to establish branches, agencies, and other offices subject to central bank’s laws, rules and regulations. 2008 Development Bank of the Philippines (DBP) took over full control of AAIIBP’s operation. The Monetary Board approved the AAIIBP’s 5-year Rehabilitation Plan, which focused on four 2009 corporate strategies: Recapitalization, Restoration of Financial Viability, Reorganization and Reforms Institutionalization. Source: Al-Amanah Islamic Investment Bank of the Philippines  Development of Islamic Banking in the Philippines ISLAMIC BANKING LAWS YEAR DESCRIPTION Enactment of Republic Act No. 11054 (The Organic Law for the Bangsamoro Autonomous Region in Muslim Mindanao – allowed to establish a political entity and provide its basic structure 2018 of government; Sec. 32 mandated to promote Islamic banking and finance development in BARMM) Enactment of Republic Act No. 11439: Islamic Banking Act (The Act of Providing for the Regulation and Organization of Islamic Banks) 2019 Issuance of BSP Circular No. 1069 (Implementing Guidelines on the Establishment of IBs and IBUs) and BSP Circular No. 1070 (Shari’ah Governance Framework) 2021 Issuance of BSP Circular No. 1116 (Guidelines on liquidity risk management of IBs and IBUs). Issuance of BSP Circular No. 1139 (Guidelines for Reporting Islamic banking and finance 2022 transactions/agreements). Amendment of the PDIC Charter to provide insurance cover for Islamic bank deposits. Source: Al-Amanah Islamic Investment Bank of the Philippines  Al-Amanah Islamic Investment Bank of the Philippines The only Islamic universal bank in the Philippines. Subsidiary of Development Bank of the Philippines (DBP). Republic Act No. 6848: Charter of Al-Amanah Islamic Bank of the Philippines of 1990. Offers both Islamic and conventional banking services. Core Values: Adherence to Shari’ah principles, Integrity, Competence and Excellence. Mission: To become a full Islamic Bank and afford Filipinos of the blessings and benefits of Islamic banking, financing, and investment. Vision: To be the leading and choice Islamic financial institution providing alternative banking services in response to the emerging global Islamic markets and to promote and accelerate the socio-economic developments of the Islamic communities in the Philippines by 2022. Source: Al-Amanah Islamic Investment Bank of the Philippines  Al-Amanah Islamic Investment Bank of the Image Source from the Internet Philippines Deposit Products: Islamic Banking Deposit Products: Conventional Current Account under “Wadiah” Current Account Savings Account under “Wadiah” Savings Account General Investment Account under “Profit Sharing Scheme” Time Deposit / Special Savings Pilgrimage Savings Plan (PSP) Bahsit Savings (BSA) Islamic Financing Products Other Services under the following principles ATM Services Murabahah Collection agreement Ijarah Islamic Microfinance Payroll Service Islamic Salary Loan Fund transfer (local and international) Qard Al-Hassan (under bank’s CSR) OFW Remittance AAIIBP Organizational Chart Source: AAIIBP Annual Report AMILBAHAR P. AMILASAN, JR. Acting Chairman & Chief Executive Officer Image Source from the Internet Al-Amanah Islamic Investment Bank of the Philippines Branches: Makati City (Office of the Chairman and CEO: DBP Building) San Juan Cagayan De Oro Cotabato Davao Jolo, Sulu Iligan General Santos Marawi Zamboanga City Source: Al-Amanah Islamic Investment Bank of the Philippines  BSP Initiatives: Awareness on Islamic Banking Major Challenge: Low awareness or low understanding of Islamic banking and finance. Capacity-building programs – undertaken by relevant agencies and institutions to promote the development of Islamic finance. Information drive – expects to have more Filipinos understand and appreciate Islamic banking. Vibrant Islamic Banking industry – promises a brighter future for Philippine economy and greater financial independence for the Filipino people. Source: Bangko Sentral ng Pilipinas  Republic Act No. 11054 (2018) Organic Law for the Bangsamoro Autonomous Region in Muslim Mindanao (BARMM) Article XIII, Section 32: Islamic Banking and Finance The Bangsamoro Government, the BSP, the DOF, and the National Commission on Muslim Filipinos shall jointly promote the development of an Islamic banking and finance system in BARMM. The law provides for the establishment of a Shari’ah Supervisory Board and the promotion and development of Shari’ah-compliant financial institutions, subject to the supervision of the BSP. Mandates the promotion of Islamic banking and finance, such as through granting tax incentives and adopting tax neutrality between conventional and Islamic financial services. Source: Bangko Sentral ng Pilipinas  Republic Act No. 11054 (2018) Organic Law for the Bangsamoro Autonomous Region in Muslim Mindanao (BARMM) Shari’ah Supervisory Board (SSB) Primarily responsible for issuing opinions on Shari’ah compliance on Islamic Banking transactions and products. Composed of nine (9) members:  Five (5) members, preferably Filipino citizens, shall come from the private sector, which shall be appointed by the Bangsamoro Government and subject to the confirmation of BSP with a term of three (3) years and may be reappointed for a maximum period of two (2) consecutive terms.  One (1) member from Bangsamoro Government (BG)  One (1) member from the Bangko Sentral ng Pilipinas (BSP)  One (1) member from Department of Finance (DOF)  One (1) member from National Commission on Muslim Filipinos (NCMF) Source: Bangko Sentral ng Pilipinas  Islamic Banking Act Republic Act No. 11439 (2019) An Act Providing for the Regulation and Organization of Islamic Banks To enable and encourage the growth of Islamic banking in the Philippines. Section 1. Declaration of Policy: The State recognizes the vital role of Islamic banking and finance in creating opportunities for greater financial inclusion, especially for the underserved Muslim population, in expanding the funding base for small and medium-sized enterprises as well as large government infrastructure through financial arrangements with risk sharing as their core element, and in contributing to financial stability through the use of financial contracts and services that are founded on risk sharing rather than speculation in compliance with Shari’ah principles. Source: Bangko Sentral ng Pilipinas  Islamic Banking Act Republic Act No. 11439 (2019) Section 5. Shari’ah Advisory Council Islamic bank shall constitute a Shari’ah Advisory Council composed of persons who are qualified in Shari’ah or who have knowledge or experience in Shari’ah and in banking, finance, law or such other related disciplines. The council shall render advice and review applications of Shari’ah principles, but it shall not involve itself directly in the operations of the Islamic bank or engage in any activity which may give rise to conflict of interest. Section 14. Tax Neutrality The Government shall endeavor to achieve neutral tax treatment between Islamic banking transactions and equivalent conventional banking transactions within the provisions of the National Internal Revenue Code of 1997 (RA 8424), as amended.. Source: Bangko Sentral ng Pilipinas  BSP Circulars on IBs and IBUs BSP Circular No. 1069 (s. 2019): Guidelines on the Establishment of Islamic Banks and Islamic Banking Units. - allows the establishment of domestic and foreign Islamic banks (IBs), and creation of Islamic banking units (IBUs) in the form of a division, department, office, or branch of a conventional bank. BSP Circular No. 1070 (s. 2019): Shari’ah Governance Framework for Islamic Banks (IB) and Islamic Banking Units (IBU). - ensures effective Board of Directors (BOD) and management oversight over Sharia compliance, creation of an independent and effective Sharia advisory council, compliance and audit functions. Source: De Castro, K. M. (2022 ). The Future of Islamic Banking in the Philippines: Finding a Niche. DLSU Business Notes and Briefings: Center for Business Research and Development..  Shari’ah Governance Framework A comprehensive system that defines a set of appropriate institutional measures, arrangements, requirements, structures and policies of an Islamic Bank (IB) and Islamic Banking Unit (IBU) to ensure that there is effective and independent oversight of Shari'ah compliance of its Islamic banking business. Board of Directors (BOD) shall be ultimately responsible and accountable for ensuring full conformity of the lB or lBU with the Shari'ah principles. Source: Bangko Sentral ng Pilipinas  BSP Circulars on IBs and IBUs BSP Circular No. 1116 (s. 2021): Guidelines on the Management of Liquidity Risk of Islamic Banks and Islamic Banking Units. - states that IBs and IBUs are expected to have written policies on liquidity risk management. BSP Circular No. 1139 (s. 2022): Guidelines for Reporting Islamic Banking and Finance Transactions/Arrangements. -states that the provisions of existing regulations under the MORB, as well as other standards of conduct prescribed by the BSP on conventional banks shall also apply to an IB and IBU of a conventional bank, unless otherwise expressly specified. Source: De Castro, K. M. (2022 ). The Future of Islamic Banking in the Philippines: Finding a Niche. DLSU Business Notes and Briefings: Center for Business Research and Development..