Essentials of Islamic Banking and Finance IRSHAD AHMAD AIJAZ irshad786@gmail

1. Advanced topics in Islamic banking Essentials of Islamic Banking and Finance IRSHAD AHMAD AIJAZ irshad786@gmail.com

2. Contents • Treasury Operations; • Capital market opearations; • Money market operations; • FX market operations; • Stock market in Islamic finance; • Relation of Islamic bank with banks; • International trade and finance and Islamic banking; • Interest rate benchmarking in Islamic banking;

3. Treasury Operations • Treasury operation are important for every financial institution; • Treasury is concerned about management of liquidity – cash; • Treasury department takes care of bank's short or long positioning; • Treasury operations comprise of main three functions: • Capital market operations; • Financial instruments of >1 year life are dealt under the umbrella of this market; • Investment in stock and bonds are done through this department;; • Money market operations; • Financial instruments of <1 year life are dealt trough this market; • Treasury bills and other short term arrangements are done through this market;

4. Treasury Operations • FX market operations: • These operations belong to trade in all sorts of currencies; • Bank manage their requirement of foreign currencies through this department; • Local and international payments are made through this department; • These three functions of treasury departments are usually done in overlapping ways; • One department may take care of other operations;

5. Treasury Operations – capital market operations • Islamic banks do not deal in bonds and other fixed income securities as they are non permissible instruments; • Islamic banks deals in Sukuk which are Islamic bands; • Details will be presented by group # ; • All stock are not eligible for investment as many of them are of banks, insurance companies and of those companies which are not acceptable in Islam; • There is criteria for selection of stocks; • This criterion is called Stock Selection Criteria;

6. Treasury Operations – capital market operations • T bills and other ways of short term liquidity management are not acceptable to Shari'ah; • There is almost no any practicable alternative for Islamic money market; • Repo and Reverse repo are buy back arrangements; • Many other ways of liquidity provisioning are not Shari'ah accepted ways;

7. Treasury Operations – FX operations • Trade of currencies is a special kind of sale which has different rules; • According to a view of some Fuqahaa’ currencies are substitute to gold and silver and thus must be exchanged on two basis: • Spot basis, • Immediate payment of both ends; • Equality of both side if the exchanged currencies are same; • Any additional amount is not allowed; • More payment for new currencies is an example of it hence not allowed; • Different currencies could be exchanged for higher and lower price; • 1 $ could be exchanged with Rs. for higher price;

8. Stock market and equity investment in Islamic finance • Stock market is part of capital market; • It deals in share of companies; • Stocks are classified in Shari'ah as a 'proof of undivided ownership in a partnership'; • The stock holder is owner of the partnership up to the value the share reflects (face value, book value or market value); • The profit a partnership earns and distribute (dividend) or increase / decrease in value of share (capital gain / loss) both go the stock holder because of his right of ownership; • A stock will be Shari’ah compliant if it does not fall under the four prohibitions we studies earlier; • Since a stock is an undivided portion in a partnership, rules of partnership (Shirkah / Musharakah) apply on stocks also;

9. Stock market and equity investment in Islamic finance • Three major issues are there in current financial system: • No concept of non-Shari’ah compliance in general prohibitions; • Majority of corporate bodies do not discriminate between Halal or Haram activities; • Involvement in Riba; • Major part of financial system is interest-based; • Companies pay interest and earn it; • No attention to laws of contract in Islam; • Partnerships do not pay attention to rules set out by Shari’ah for partnerships;

10. Stock market and equity investment in Islamic finance • Now, three possible status of business activities of a firm are there: • Purely Haram business activities; • Film making, pornography, liquor making/ trading, gambling companies, conventional financing companies, banks and conventional insurance are example of this type; • Some scholar include unethical businesses in this type like weapon industry and tobacco companies in this category as well; • Purely Halal business activities; • Almost all manufacturing and general business activities are example of this kind; • Mixed business activities; • The companies that are involved primarily in Halal business but they have some involvement in non-Shari’ah compliant activities; • The structure of big companies is generally of this nature;

11. Stock market and equity investment in Islamic finance • Fatwas about these companies: • The first category is absolutely Haram with no ambiguity; • The second category is Halal completely; • The third category is a point of discussion; • Majority of companies involve in interest based activities; • Fuqaha have explained some flexibilities in state of need; • Therefore Ulema have set two criteria: • If a firm is leveraged (from interest bearing loans) then this should not be more than majority • If a firm is earning interest then this income: • Must not be in considerable size; • Must be subtracted from total income (purification process);

12. Regulator (SBP or SECP) Other Islamic Financial Intermediary Other Non Islamic Financial Intermediary Other Islamic Financial Intermediary Other Islamic Financial Intermediary Islamic Financial Intermediary – Bank or Insurance Co. Depositors Customers • Mudarabah • Musharakah • Many types of funding are possible; • Trade, Rental and Partnership; • Regulator; • Ameen – Islamic banks deposit money without taking any profit – CRR and SLR requirements • Regulator; • Ameen – Islamic banks deposit money without taking any profit – CRR and SLR requirements • Can not invest with this bank; • May have other transaction based relation – trading of goods. Relationship of Islamic bank with other banks