PAPER WORK

Financial Markets and Institutions "Financial Insititution of Turkey" "Islamic Banking"

CONTENT :

1-) Introduction of "Islamic Banking"

2-) Foundations of "Islamic Banking"

3-) Islamic Financial Rules

4-) Islamic banking in Turkey

5-) Islamic banks during crisis

6-) Risk Management in islamic banking

7-) Competitive Analysis of islamic banking

8-) Conclusions

9-)References

INTRODUCTION

People lives for their rights and belives, and relegions are one of the bigest step which lead them to organise their life style about it. In every relegion there are some rules which they ask to obey their belivers of it. Some of them to protect people from harm or some of time in many different things.Islamic banking has born by this kind of needs.Islam rules the people that they shouldnt get profit form without doing something.From a situation nearly 30 years ago when it was virtually unknown, Islamic banking has expanded to become a distinctive and fast growing segment of the international banking and capital markets. There are well over 200 Islamic banks operating in over 70 countries comprising most of the Muslim world and many Western countries. Not included in these figures are the 50 Islamic insurance (takaful) companies operating in 22 countries, Islamic investment houses, mutual funds, leasing companies and commodity trading companies. Also excluded are the very largest Islamic banks engaged at a multilateral level. To these numbers must be added the many hundreds of small Islamic financial institutions such as

rural and urban cooperative credit societies, Islamic welfare societies and financial asso- ciations operating at a local level and dealing with rural entities, small business firms and individual households.

Many people are interested in the phenomenon of Islamic banking and in the question of how it di ersff from conventional banking, yet, despite the expansion over the last 30 years, Islamic banking remains poorly understood in many parts of the Muslim world and continues to be a mystery in much of the West. Our aim in this volume is to provide a suc- cinct analysis of the workings of Islamic banking and finance, accessible to a wide range of readers.

There is now a considerable amount of research on the topic and, in what can be con- sidered as a companion to this volume, we have collected together some of the most sig- nificant previously published articles on the subject covering the last four decades (Hassan and Lewis, 2007). Inevitably, however, there were large gaps in the coverage of topics (notably in the treatment of operational e ciencyffi , marketing, project finance, risk man- agement, mutual funds, the stock market, government financing, multilateral institutions and financial centres) and a narrow number of themes were pursued in these journal arti- cles written, in most cases, for specialist researchers in the field.

This volume seeks to bring the research agenda and the main issues on Islamic banking before a wider audience. For this reason we invited leading scholars to write chapters on various aspects of Islamic banking and report on the current state of play, and the debates, involved. The essays aim to provide a clearly accessible source of reference mate- rial on current practice and research.

Before introducing the individual contributions, a word of explanation is needed about the title. When the subject matter first began to be written about, it was usual to use the terms ‘Islamic banks’ and ‘Islamic banking’. Nowadays, it has become more common- place to talk of Islamic finance and Islamic financial institutions, reflecting in part the shift – evident in Western markets as well as Islamic ones – away from what used to be banking activities to financing activities more generally, previously carried out by invest- ment companies and assorted non-banking intermediaries. Nevertheless, so long as this wider agenda is recognized, we prefer the simplicity of the original terms.

4Foundations of Islamic bankingAn Islamic banking and financial system exists to provide a variety of religiously accept- able financial services to the Muslim communities. In addition to this special function, the banking and financial institutions, like all other aspects of Islamic society, are expected to ‘contribute richly to the achievement of the major socio-economic goals of Islam’ (Chapra, 1985, p. 34). The most important of these are economic well-being with full employment and a high rate of economic growth, socioeconomic justice and an equitable distribution of income and wealth, stability in the value of money, and the mobilization and investment of savings for economic development in such a way that a just (profit- sharing) return is ensured to all parties involved. Perhaps the religious dimension should be presented as a further explicit goal, in the sense that the opportunity to conduct reli- giously legitimate financial operations has a value far beyond that of the mode of the financial operation itself.

In Chapter 2, Masudul Choudhury notes that Islamic banks have mushroomed under an Islamization agenda, but the system has not developed a comprehensive vision of an interest-free system, nor has it mobilized financial resources for enhancing social wellbe- ing by promoting economic development along Islamic lines. These omissions, he argues, are shared more generally by Islamic economic thinking and social thought which has produced no truly Qur’anic worldview and has failed to understand the dynamics of Islamic transformation within an equitable and participatory framework. Choudhury comes to this conclusion after reviewing the social theory developed from the early years of Islam to the present day. In advocating the rediscovery of a worldview founded on the doctrine of Tawhid (the oneness of God) as enunciated by the Holy Qur’an and sunna, Choudhury envisages a social wellbeing function for Islamic banks in terms of social security, protection of individual rights and resource mobilization in keeping with the Islamic faith.

Financial systems based in Islamic tenets are dedicated to the elimination of the payment and receipt of interest in all forms. It is this taboo that makes Islamic banks and other financial institutions different in principle from their Western counterparts. The fundamental sources of Islam are the Holy Qur’an and the sunna, a term which in Ancient Arabia meant ‘ancestral precedent’ or the ‘custom of the tribe’, but which is now syn- onymous with the teachings and traditions of the Prophet Muhammad as transmitted by the relators of authentic

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tradition. Both of these sources treat interest as an act of exploitation and injustice and as such it is inconsistent with Islamic notions of fairness and property rights. Islamic banking thus derives its specific raison d’être from the fact that there is no place for the institution of interest in the Islamic order.

Some scholars have put forward economic reasons to explain why interest is banned in Islam. Anwar Iqbal Qureshi ([1946] 1991) believes that it is not necessary to o erff intel- lectual arguments in favour of the Qur’anic injunction against riba. The real question, however, is not about riba but about the definition of riba. Latifa Algaoud and Mervyn Lewis in Chapter 3 examine the nature of riba, distinguishing between riba that relates to loans and riba that involves trade, before going on to consider the divergent positions taken by traditionalists and modernists on the definition of riba. They also point out that the Islamic critique is based on more than the prohibition on interest, even if we over- look the broader social charter recommended by Choudhury and others. There is also the prohibition in Islam of maysir (gambling, speculation) and gharar (unreasonable

uncertainty), the need to ensure that investment be undertaken on the basis of halal (per- mitted) activities, and the requirement to benefit society through the collection of zakat (almsgiving) overseen by a special religious supervisory board.

This rejection of interest by Islam poses the question of what replaces the interest rate mechanism in an Islamic framework. If the paying and receiving of interest is prohibited, how do Islamic banks operate? Here PLS comes in, substituting profit-and-loss-sharing for interest as a method of resource allocation. Although a large number of different con- tracts feature in Islamic financing, certain types of transaction are central: trustee finance (mudaraba), equity participation (musharaka) and ‘mark-up’ methods. Some of these profit-sharing arrangements such as mudaraba and musharaka almost certainly pre-date the genesis of Islam. Business partnerships based on what was in essence the mudaraba concept coexisted in the pre-Islamic Middle East along with interest loans as a means of financing economic activities (Crone, 1987; Kazarian, 1991; Cizaka, 1995). Following the birth of Islam, interest-based financial transactions were forbidden and all finance had to be conducted on a profit-sharing basis. The business partnership technique, utilizing the mudaraba principle, was employed by the Prophet Muhammad himself when acting as agent (mudarib) for his wife Khadija, while his second successor Umar ibin al-Khattab invested the

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money of orphans with merchants engaged in trade between Medina and Iraq. Simple profit-sharing business partnerships of this type continued in virtually unchanged form over the centuries, but they did not develop into vehicles for large-scale investment involving the collection of large amounts of funds from large numbers of individual savers. This development did not happen until the growth of Islamic financial institutions.

This leads us to, by Abbas Mirakhor and Iqbal Zaidi which provides an account of both the traditional financial instruments, mudaraba, musharaka and mark- up (murabaha, ijara, salam, bai bi-thamin ajil, istisnaa), along with the newly developed sukuks. Mirakhor and Zaidi explain in detail the features that make these instruments acceptable from an Islamic viewpoint, and the implications which follow from an agency theory perspective for the contractual relationships involved. They then consider some practical issues involved in the development of Islamic structured finance in the form of asset-backed securities, covered bonds, sukuks and collateralized securitization. Finally, the authors review the future of the profit-and-loss sharing principle in the light of these innovative financing arrangements.

Following on from these analyses of the economic and social principles underlying Islamic financing, the nature of the Islamic critique of conventional financial systems, and the present-day Islamic alternative, the last chapter in this section brings a different per- spective to the issues, for Islam is not the only (or indeed the first) religion to prohibit usury (interest). In Ancient India, laws based on the Veda, the oldest scriptures of Hinduism, condemned usury as a major sin and restricted the operation of interest rates (Gopal, 1935; Rangaswami, 1927). In Judaism, the Torah (the Hebrew name of the Law of Moses or the Pentateuch, the first five books of the Old Testament) prohibited usury amongst the Jews, while at least one authority sees in the Talmud (the Oral Law which supplements the Written Scriptures for orthodox Jews) a consistent bias against ‘the appearance of usury or profit’ (Neusner, 1990). Under Christianity, prohibitions or severe restrictions upon usury operated for over 1400 years, but gradually the Christian Church bowed to the pressures of reformist theologians and the needs of commerce and came to see only exorbitant interest as usurious.

Islamic financing rules 6

The five elements mentioned above give Islamic banking and finance its distinctive reli- gious identity, and we now briefly explain each in turn.

Riba

Perhaps the most far-reaching and controversial aspect of Islamic economics, in terms of its implications from a Western perspective, is the prohibition of interest (riba). The payment of riba and the taking of interest as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an, and thus investors must be compensated by other means. It is further stated in the Holy Qur’an that those who disregard the prohibi- tion of interest are at war with God and His Prophet Muhammad.

Haram/halal

A strict code of ‘ethical investments’ operates for Islamic financial activities. Hence Islamic banks cannot finance activities or items forbidden (that is, haram) in Islam, such as trade of alcoholic beverages and pork meat. Furthermore, as the fulfilment of mater- ial needs assures a religious freedom for Muslims, Islamic banks are encouraged to give priority to the production of essential goods which satisfy the needs of the majority of the Muslim community. As a guide, participation in the production and marketing of luxury activities, israf wa traf, is considered as unacceptable from a religious viewpoint when Muslim societies suffer from a lack of essential goods and services such as food, clothing, shelter, health and education.

Gharar/maysir

Prohibition of games of chance is explicit in the Holy Qur’an (S5: 90–91). It uses the word maysir for games of hazard, derived from usr (ease and convenience), implying that the gambler strives to amass wealth without effort, and the term is now applied generally to all gambling activities. Gambling in all its forms is forbidden in Islamic jurisprudence. Along with explicit forms of gambling, Islamic law also forbids any business activities which contain any element of gambling (Siddiqi, 1985). The shari’a determined that, in the interests of fair, ethical dealing in commutative contracts, unjustified enrichment through games of pure chance should be prohibited.

Another feature condemned by Islam is economic transactions involving elements of speculation, gharar (literally ‘hazard’). While riba and maysir are condemned in the Holy Qur’an, condemnation of gharar is supported by ahadith. In business terms, gharar means to undertake a

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venture blindly without su cientffi knowledge or to undertake an excessively risky transaction, although minor uncertainties can be permitted when there is some neces- sity. In a general context, the unanimous view of the jurists held that, in any transaction, by failing or neglecting to define any of the essential pillars of contract relating to the consideration or measure of the object, the parties undertake a risk which is not indispens- able for them. This kind of risk was deemed unacceptable and tantamount to speculation because of its inherent uncertainty. Speculative transactions with these characteristics are therefore prohibited.

This prohibition applies in a number of circumstances, such as when the seller is not in a position to hand over the goods to the buyer or when the subject matter of the sale is incapable of acquisition, for example the sale of fruit which is not yet ripened, or fish or birds not yet caught; that is, short-selling. Speculative business, like buying goods or shares at low prices and selling them for higher prices in the future, is considered to be illicit.

Zakat

According to the Holy Qur’an, God owns all wealth, and private property is seen as a trust from God. Property has a social function in Islam, and must be used for the benefit of society. Moreover, there is a divine duty to work. Social justice is the result of organizing society on Islamic social and legal precepts, including employment of productive labour and equal opportunities, such that everyone can use all of their abilities in work and gain just rewards from that work e ort.ff Justice and equality in Islam means that people should have equal opportunity and does not imply that they should be equal either in poverty or in riches (Chapra, 1985). However, it is incumbent on the Islamic state to guarantee a sub- sistence level to its citizens, in the form of a minimum level of food, clothing, shelter, medical care and education (Holy Qur’an 58: 11). The major purpose here is to moderate social variances in Islamic society, and to enable the poor to lead a normal, spiritual and material life in dignity and contentment.

A mechanism for the redistribution of income and wealth is inherent in Islam, so that every Muslim is guaranteed a fair standard of living, nisab. Zakat is the most important instrument for the redistribution of wealth. This almsgiving is a compulsory levy, and con- stitutes one of the five basic tenets of Islam. The generally accepted amount of the zakat is a one-fortieth (2.5 per cent) assessment on assets held for a full year (after a small initial exclusion, nisab), the purpose of which is to transfer income

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from the wealthy to the needy.

Islamic banking in Turkey :

ALBARAKATURK:

Albaraka Turk, the first finance institution and the pioneer in the field of interest-free banking, completed its establishment in 1984 and commenced operations in the beginning of 1985. Albaraka Turk continues its operations in compliance with the Law of Banking numbered 5411. Albaraka Turk was founded by Albaraka banking Group (ABG), one of the prominent groups of the Middle East, Islamic Development Bank (IDB) and a native industrial group of Turkey, which served the Turkish economy for more than half a century. As of 31.05.2012, in the partnership structure of Albaraka Turk, foreign partners are 66.16%, native partners are 11.06% and shares open to the public is 22.78%. The structure of Albaraka's partnership is the guarantee of the reputataion and trust we already have.

Albaraka, which collects funds through current and participation accounts and in turn circulates the funds into the economy through individual finance, corporate finance, financial leasing and profit/loss sharing based on projects, etc, is authorized to provide various financial and banking services through interest-free banking applications.   

Albaraka, which commenced banking with the vision of becoming the best in the region in presenting financial products and services in the regions ( The Gulf, Middle East and South Africa) where its main partner Albaraka Banking Group operates,  is able to provide its customers with superior, rapid and secure foreign trade (import, export and foreign exchange) thanks to a wide network of correspondent banks. Our network is comprised of over 796 banks operating in over 72 countries around the world, from Singapore to U.K., from South Africa to Morocco, and from Australia to Kazakhstan. 

Albaraka, who is ambitious in the field of Individual Banking, has been operating, as of 31.05.2012, with its 129 branches all over the country and 1 branch abroad; (for a total of 130 branches) 54 of which are in Istanbul and 75 of which are in the prominent industry and trade centers of Turkey, as an international participation bank that has adopted the mission of adding value to its customers, shareholders, employees and Turkey.

Islamic banks during crisis :

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RISK MANAGEMENT IN ISLAMIC BANKING :

Risk entails both vulnerability of asset values and opportunities of income growth. Successful firms take advantage of these opportunities (Damodaran, 2005). An impor- tant element of management of risk is to understand the risk–return trade-off of different assets and investors. Investors can expect a higher rate of return only by increasing their exposure to risks. As the objective of financial institutions is to create value for the share- holders by acquiring assets in multiples of shareholder-owned funds, managing the result- ing risks faced by the equity becomes an important function of these institutions.Credit risk

Credit risk is the loss of income arising as a result of the counterparty’s delay in payment on time or in full as contractually agreed. Such an

eventuality can underlie all Islamic

modes of finance. For example, credit risk in murabaha contracts arises in the form of the counterparty defaulting in paying the debts in full and in time. The non-performance can be due to external systematic sources or to internal financial causes, or be a result of moral hazard (wilful default). Wilful default needs to be identified clearly as Islam does not allow debt restructuring based on compensations except in the case of wilful default. In the case of profit-sharing modes of financing (like mudaraba and musharaka) the credit risk will be non-payment of the share of the bank by the entrepreneur when it is due. This problem may arise for banks in these cases because of the asymmetric information problem where they do not have su cientffi information on the actual profit of the firm.Market riskMarket risks can be systematic, arising from macro sources, or unsystematic, being asset- or instrument-specific. For example, currency and equity price risks would fall under the systematic category and movement in prices of commodity or asset the bank is dealing with will fall under specific market risk. We discuss a key systematic and one unsystem- atic risk relevant to Islamic banks below.

Mark-up risk Islamic financial institutions use a benchmark rate to price di erentff finan- cial instruments. For example, in a murabaha contract the

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mark-up is determined by adding the risk premium to the benchmark rate (usually the LIBOR). The nature of a murabaha is such that the mark-up is fixed for the duration of the contract. Consequently, if the bench- mark rate changes, the mark-up rates on these fixed income contracts cannot be adjusted. As a result Islamic banks face risks arising from movements in market interest rate. Mark- up risk can also appear in profit-sharing modes of financing like mudaraba and musharaka as the profit-sharing

ratio depends on, among other things, a benchmark rate like LIBOR.2

Commodity/asset price risk

The murabaha price risk and commodity/asset price risk must be clearly distinguished. As pointed out, the basis of the mark-up price risk is changes in LIBOR. Furthermore, it arises as a result of the financing, not the trading process. In contrast to mark-up risk, commodity price risk arises as a result of the bank holding commodities or durable assets as in salam, ijara and mudaraba/musharaka. Note that both the mark-up risk and commodity/asset price risk can exist in a single contract. For example, under leasing, the equipment itself is exposed to commodity price risk and the fixed or overdue rentals are exposed to mark-up risks.

Liquidity riskLiquidity risk arises from either di cultiesffi in obtaining cash at reasonable cost from bor- rowings (funding liquidity risk) or sale of assets (asset liquidity risk). The liquidity risk arising from both sources is critical for Islamic banks. For a number of reasons, Islamic banks are prone to facing serious liquidity risks. First, there is a fiqh restriction on the securitization of the existing assets of Islamic banks, which are predominantly debt in nature. Second, because of slow development of financial instruments, Islamic banks are also unable to raise funds quickly from the markets. This problem becomes more serious because there is no inter-Islamic bank money market. Third, the lender of last resort (LLR) provides emergency liquidity facility to banks whenever needed. The existing LLR facilities are based on interest, therefore Islamic banks cannot benefit from these.

Bundled risksIt is uncommon for the various risks to be bundled together. However, in the case of most Islamic modes of finance, more than one risk coexists. For example, in salam, once the bank has made an advance payment, it has started to take the counterparty risk concerning delivery of the right commodity on time, the market risk of the commodity, the liquidity risk

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of its conversion into cash, the operational risk of its storing and movement and so on. The same is the case with istisnaa, financial murabaha, ijara and musharaka/mudaraba.

Risks in different Islamic modes of financingRisks in Islamic modes of financing are complex and evolve. Table 10.1 reports the per- ceptions of 18 Islamic bankers on some important risks

inherent in various Islamic modes of financing.4

The figures in the table show the ranking of seriousness of risks, with higher figures indicating the relative severity of risks.

Credit risk appears to be the least in murabaha (2.47) and the most in musharaka (3.71), followed by diminishing musharaka (3.43) and mudaraba (3.38). It appears that profit- sharing modes of financing are perceived by the bankers to have higher credit risk. Ijara ranks second (2.64) after murabaha as having the least credit risksLike the murabaha con- tract, the ijara contract gives the banks a relatively certain income and the ownership of the leased asset remains with the bank. Istisnaa and salam, ranked 3.13 and 3.20 respec- tively, are relatively more risky. These product-deferred modes of financing are perceived to be riskier than price-deferred sale (murabaha). This may arise as the value of the product (and hence the return) at the end of the contract period is uncertain. There are chances that the counterparty may not be able to deliver the goods on time. This may arise for different reasons, such as natural disasters (for commodities in a salam contract) and production failure (for products in istisnaa contract). Even if the good is delivered, there.

Credit risk Market risk

Liquidity risk

Operational riskMurabaha 2.47 (17) 2.75 (12) 2.62 (16) 2.8 (15)

Mudaraba 3.38 (13) 3.56 (9) 2.57 (14) 2.92 (13)Musharaka 3.71 (14) 3.67 (9) 3.0 (13) 3.08 (12)Ijara 2.64 (14) 3.17 (6) 3.1 (10) 2.9 (10)Istisnaa 3.13 (8) 2.75 (4) 3.0

(6)3.29 (7)

Salam 3.20 (5) 3.25 (4) 3.2 (5)

3.25 (4)Diminishing 3.43 (7) 3.5 (6) 3.43 (7) 3.17 (6)

musharaka

Note: The numbers in parentheses indicate the number of respondents; the scale is 1 to 5, with 1 indicating ‘not serious’ and 5 denoting ‘critically serious’.

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Competitive Analysis of islamic banking:

Marketing of Islamic financial products is faced with various types of competitive pres- sures from conventional banks. In this environment, Islamic banks have to formulate and implement successful marketing strategies in which a key ingredient is a clear under- standing of the behaviour, attitudes and perceptions of their clients. This is achieved through identifying behavioural profiles encompassing banking habits, selection criteria used by target markets, risk-tolerance levels, awareness, preferences and usage patterns of various Islamic bank products (Metawa and Almossawi, 1998). Also Islamic banks o erff many of the conventional banking services such as ATM machines, and credit cards to their clients at competitive prices.

Conveying trust and pietyAmong the more important attractions Islamic banks aim to portray are the characteris- tic traits of trust and piety. As Islamic-based institutions,

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the banks foster a God-abiding, trustworthy and pious image, that is well recognized and appreciated by religious con- sumers, o eringff a sense of reassurance that their investments are lawful (halal).

Conveying credibility and experienceLike conventional banks, Islamic banks aim to convince customers of their investment experience. An inexperienced customer, seeking a way to invest his/her savings, strongly appreciates evidence of credibility and past investment performance. In this way, the perhaps daunting task of investing is made easier and within reach.Complementing regular banksIslamic banks’ marketing strategy can be complementary to that of conventional banks. Services not o ered bff y Islamic banks may be acquired from regular conventional banks while maintaining a sense of religious peace and trust by continuing the relationship with the Islamic banks.

Conclusion:in our time , economy is moving the way of people needs, and people preferences.Islamic banking system is one of a good example for that. People who has same mind of thinking being together and create a investment strategy like a bank and getting profit from such financial insitutations. Islamic banking is the way how people can get profit to taking some risk of their money, only with that way is they are able to get to use their money.In recent years a number of initiatives have been taken to strengthen the Islamic financial architecture. Under the leadership of the Islamic Development Bank and with active support from international institutions such as the World Bank, IMF and the Basle Committee, several international Islamic financial institutions have been established. In addition, though many of the traditional infrastructure arrangements for conventional finance, such as payment systems, trading arrangements and information systems, are also available to IFIs, in most cases the operational modalities need to be adjusted in varying degrees to accommodate the specific requirements of IFIs. To make these adjustments, a ‘functional approach’ towards building the infrastructure of the Islamic financial indus- try is needed. The functions being performed by various institutions in the conventional framework should be examined and attempts should be made to modify the existing insti- tutions in a way that enables them to provide better support, or establish new ones as needed.he Islamic financial industry has a bright future, but it will be

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achieved only if the past achievement on the one hand and the floodlight of imminent changes on the other do not blind its active players.

Rerefences :

1-) Albarakaturk.com.tr , Albaraturk Bank - history

2-) Development of Islamic banking guide book, Ebu Nazzir Al mah

3-) en.wikipedia.org/wiki/Islamic_banking Wikipedia, islamic banking

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