Islamic financial system

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ABSTRACT

Banking is considered one of the main components of the financial systems. It has a huge impact into the financial stability and the real strength of the economy. Banking system connects all the main units of fundamental economics and play intermediation role. It helps to interconnect economic relations. Consequently, any transaction of conventional banks has significant impact for the overall economy, because of conventional banks' heavy reliance on interest rates which are either market forced or state governed.

The term "Islamic financial system" emerged in the mid-1980s. The Islamic financial system is often described as a financial system that does not imply a collection of interest. However, the principles of Islamic finance are significantly wider than the failure of the interest rate. They are based on Sharia - a collection of rules and laws related to management of the economy, social, political and cultural aspects of Islamic society. Due to the use of non-compliance with these laws generally accepted financial instruments in the Muslim world, is associated with considerable difficulties.

In the last decade, the concept of "Islamic Bank" is well established in the lexicon of financiers in many developed countries. This financial institution operates in Muslim countries, is beginning to play an increasingly important role in the traditional financial system. And in countries such as the UK and the U.S., where the number of citizens who practice Islam, and refusing to use the services of traditional banks has increased many times to ignore Islamic institutions is no longer possible. In 2005, the attempt to open an Islamic banking was made in Kyrgyzstan. Therefore, the study of Islamic financial institutions is quite a hot topic in the economic literature, as well as of practical interest for the economic agents in our country and abroad.

The purpose of this paper is to describe the basic principles of the functioning of the Islamic financial system, as well as the consequences of the emergence of Islamic financial institutions in the traditional financial markets. In the coming years, some of these institutions may broadcast their influence in Kyrgyzstan, so the domestic banks, non-financial enterprises, public authorities and the public must be prepared for such a development and realize the consequences of this trend for the economy of the country.

Often, the little that is known about the Islamic financial institutions, ban reduced to profit at the expense of obtaining bank interest and taking excessive risks, including through the use of derivative financial instruments. In this case, the rapid development of Islamic banks necessitates learn more about the features of their functioning. In particular, it is interesting to study the basic products offered.

Islamic banks, models of their balance sheets, as well as ways of adapting the Islamic financial institutions to traditional financial systems.

Islamic banking is a growing phenomenon involving a variety of institutions and instruments. Previously, Islamic banking made up a small part of a banking industry. Recently, Islamic banks has significantly expanded their network, and have been able to upgrade many economic ventures and mobilize huge amount of funds. The enormous growth and widespread expansion of Islamic banking industry in the financial markets of the world has made this newly born industry a ground reality. Nowadays in 75 countries works more than 400 banks. Their assets in 2012 was around 1.1 trillion. Another factor of the attraction of Islamic banking industry is the resilience that Islamic banks have shown in the current global financial crisis.

Our study has the following structure. In the first part, we look at the basic principles of the Islamic banking system. In particular, we describe the structure of a typical Islamic financial system, the financial instruments used by Islamic banks; we analyze the structure of the balance of an Islamic financial institution, as well as analyze the risks inherent in Islamic banks. In addition, we discuss some aspects of the regulation of Islamic financial institutions. In the second part, we will try to highlight the main problems faced by Islamic financial institutions at the entrance to the traditional financial markets.

Consideration will be given the necessary conditions that must be met before the advent of Islamic banks in the traditional financial system, and analyzes the main stages of the development of the Islamic financial sector. The role of supervisory authorities in the regulation of Islamic financial institutions and financial issues of creating the infrastructure necessary for the normal functioning of Islamic banks.



1. Introduction

This chapter will provide the background for the thesis and give a detailed statement of the purpose, as well as the describing the next chapters.

1.1 Background

Banking is considered one of the main components of the financial systems. It has a huge impact into the financial stability and the real strength of the economy. Banking system connects all the main units of fundamental economics and play intermediation role. It helps to interconnect economic relations. Consequently, any transaction of conventional banks has significant impact for the overall economy, because of conventional banks' heavy reliance on interest rates which are either market forced or state governed.

The term "Islamic financial system" emerged in the mid-1980s. The Islamic financial system is often described as a financial system that does not imply a collection of interest. However, the principles of Islamic finance are significantly wider than the failure of the interest rate. They are based on Sharia - a collection of rules and laws related to management of the economy, social, political and cultural aspects of Islamic society. Due to the use of non-compliance with these laws generally accepted financial instruments in the Muslim world, is associated with considerable difficulties.

In the last decade, the concept of "Islamic Bank" is well established in the lexicon of financiers in many developed countries. This financial institution operates in Muslim countries, is beginning to play an increasingly important role in the traditional financial system. And in countries such as the UK and the U.S., where the number of citizens who practice Islam, and refusing to use the services of traditional banks has increased many times to ignore Islamic institutions is no longer possible. In 2005, the attempt to open an Islamic banking was made in Kyrgyzstan. Therefore, the study of Islamic financial institutions is quite a hot topic in the economic literature, as well as of practical interest for the economic agents in our country and abroad.

The purpose of this paper is to describe the basic principles of the functioning of the Islamic financial system, as well as the consequences of the emergence of Islamic financial institutions in the traditional financial markets. In the coming years, some of these institutions may broadcast their influence in Kyrgyzstan, so the domestic banks, non-financial enterprises, public authorities and the public must be prepared for such a development and realize the consequences of this trend for the economy of the country.

Often, the little that is known about the Islamic financial institutions, ban reduced to profit at the expense of obtaining bank interest and taking excessive risks, including through the use of derivative financial instruments. In this case, the rapid development of Islamic banks necessitates learn more about the features of their functioning. In particular, it is interesting to study the basic products offered.

Islamic banks, models of their balance sheets, as well as ways of adapting the Islamic financial institutions to traditional financial systems.

Islamic banking is a growing phenomenon involving a variety of institutions and instruments. Previously, Islamic banking made up a small part of a banking industry. Recently, Islamic banks has significantly expanded their network, and have been able to upgrade many economic ventures and mobilize huge amount of funds. The enormous growth and widespread expansion of Islamic banking industry in the financial markets of the world has made this newly born industry a ground reality. Nowadays in 75 countries works more than 400 banks. Their assets in 2012 was around 1.1 trillion. Another factor of the attraction of Islamic banking industry is the resilience that Islamic banks have shown in the current global financial crisis.

Our study has the following structure. In the first part, we look at the basic principles of the Islamic banking system. In particular, we describe the structure of a typical Islamic financial system, the financial instruments used by Islamic banks; we analyze the structure of the balance of an Islamic financial institution, as well as analyze the risks inherent in Islamic banks. In addition, we discuss some aspects of the regulation of Islamic financial institutions. In the second part, we will try to highlight the main problems faced by Islamic financial institutions at the entrance to the traditional financial markets.

Consideration will be given the necessary conditions that must be met before the advent of Islamic banks in the traditional financial system, and analyzes the main stages of the development of the Islamic financial sector. The role of supervisory authorities in the regulation of Islamic financial institutions and financial issues of creating the infrastructure necessary for the normal functioning of Islamic banks.

Banking industry is playing the tremendous role towards economic development and wellbeing of any society. Banking activities are crucial for healthy economy, which leads towards the list of developed nations of the world. Industrial revolution during 18^th century has expanded the trade and business activities by the inception of large-scale production. Banking gained importance as an essential facility to promote business operations. In today's global and borderless market, product/service quality and customer satisfaction may increase the performance of banks for the successful survival.

In addition, an increasing interest for sustainable and ethical financial products has been noticed recently. In general, it is becoming more important for consumers to find financial products that offer both revenues and the opportunity to make a good deed, and the meaning of the investment is becoming more valuable than the actual profit (Svenska Dagbladet 2010).

Furthermore, with the ongoing globalization there is an increase in the spread and exchange of information, cultures and values around the globe. This leads to people having a more open-minded attitude towards new business methods and alternative ways of doing business. In this changing environment, companies that provide options that go beyond the traditional easily become rooted onto new markets (Dicken 2007).

By the way, let us start from the system of banking industry. They accept deposits from general public and advance loans to entrepreneurs to enhance investment activities that are inevitable for a healthy economy. Banks develop a link between surplus and deficit units to promote the trade and business activities. The role of bank is shown in the following manner.

Figure 1.1

Role of financial intermediaries (banks)

Financial intermediaries facilitate the investors to provide finance according to their requirement by considering the risks and returns attached to different projects. Banks pool the funds by accepting deposits from the savers and provide these funds to entrepreneurs for productive ventures to generate profits. An efficient inter-mediation increases the productivity and return of investment for long term benefits.

While conventional banking uses the interest rate mechanisms to perform its operational tasks, Islamic banking, by contrast, neither charges nor pays interest but rather relies on the principle of profit-and-loss sharing. Based on this concept, Islamic transactions are similar to equity-based transactions in rewarding performance. Specifically, Islamic law requirements ensure that more emphasis is placed on reward for effort rather than reward for merely owning capital. However, given the special features and characteristics of Islamic finance, modern Islamic banking has developed techniques that replace interest income with cash flows from productive sources. It particularly attempts to find more socially acceptable and attainable substitute to the interestbearing modes of financing in the desire to provide justified distribution of wealth and income.

1.2 Objective and Organization

The Islamic banking system is currently growing fast through many Arab and Muslim countries. The success of this new system is in the rapid growth of banks, branches, accounts, and of course sums of money it handles. This tremendous success in banking sector has caused some Western style commercial banks, in Kyrgyzstan for example, to consider changing to the Islamic banking system. It has also pushed many Muslim countries to seriously supporting the system.

Although the main reason to success of this system is in Islamic beliefs of the people of these countries. This paper presents not only success of this system but also highlights the dangers that future operations of the Islamic banking might counter. In addition, here we will show you examples of Islamic banking system in different countries and cultures like Malaysia, England and the current position of Islamic banking system in Kyrgyzstan.

1.3 Disposition of the Thesis

A disposition of the thesis different chapters is presented in figure 1 and is thereafter followed by a short summary of each chapter.



2. Methodology

In this chapter the methods used for the collection and interpretation of data is presented. Furthermore the implementation of the case study and will include History& Literature.

This research uses a qualitative study to investigate the development and growth of the Islamic finance and banks institutions In Kyrgyzstan and to describe and explore challenges and issues faced by Kyrgyz Islamic finance and banks.

2.1 Research - Approach and Design

The qualitative and descriptive approach will be used in this research for this thesis. Books and journal articles used to provide the information and to establish concept of Islamic banking system. Along with these sources, I also added data from World Bank



3. Islamic Banking

Here the Islamic banking system is explained and compared to the conventional banking system.

3.1 Historical Background of Islamic banking and finance

Islamic banks and financial institutions are a part of the Islamic economic system

and were established to achieve certain socio-economic objectives in accordance with the concepts of the Sharia laws that are based on the Holy Quran. According to the Holy Quran, Islam is an ideology of social development that requires all individuals and businesses to conduct themselves ethically and in a socially responsible manner. For over a thousand years, the Islamic state existed in some shape and or form, independent and powerful, which served as a beacon of inspiration for Muslim identity and fortunes. In under a mere hundred years since the death of Prophet Muhammad in 632 the Islamic state spread through both expansion and conquest into an empire more powerful and advanced than ever seen by humanity. This great civilization developed political, social, and legal institutions and frameworks that allowed it to flourish thousands of miles in either direction from its original source. During the Middle Ages while Christian Europe was experiencing its Dark Ages the new Muslim Empire flourished from Baghdad to Cordoba and served as the world's center of learning and culture. Even after the Mongol invasion and the fall of Baghdad in 1258 and the subsequent turbulent history afterwards, the Muslim, most notably under the Ottomans Empire was able to take its place allowing Muslims to live in an Islamic state where Sharia remained as the guiding factor for society that served as the important beacon of identity to all Muslims where it was possible to fulfill their duty to God.¹

The dominant principle of Islamic economics is that of the responsibility for the stewardship of property, derived from the belief in God as creator: The Almighty Allah is the real Owner of everything. Man is no more than His trustee. Man in Islam is Allah Khalifa (vicegerent) and representative on earth. As His trustee, man is obligated to obey the instructions of the One who appointed him in this capacity.²

By the nineteenth century the ability for Muslims to fulfill their duty of serving as God's representative (khalifah) was severally inhibited by European colonialism. As a result much of the Muslim world forced upon a path of Westernization and modernization that led to blind adaption of European modes of operation in areas such economics, education and even politics. Instead of applying Islamic modes they started blindly adopt West's products, codes, and politics. Which affect directly to the economy and culture. They started to immigrate from villages to crowded cities that had insufficient social support systems, the breakdown of traditional family, religious, and social values, and the adoption of a western lifestyle that once was a symbol of modernity but became increasingly criticized as the primary source of moral decline and spiritual malaise.

When they face the reality of having the Western culture and modes being Muslims. They started to think about to adapt the basic principles of Sharia to the changing conditions of life in each generation. This kind of movements, most time associated with the Sufi orders, all ultimately failed due to the technological and military dominance of the West. Finally, any possibility and hope for Pan-Islam and Muslim Unity on a global level was crushed with the elimination of the Ottoman Empire and with it any real countervailing power to that of the West.³

In twentieth century by the development of Islamic economics' and consequently Islamic finance and banks is a result of Islamic sociology where Sharia law strictly ruled what a Muslim is allowed or not allowed to do. According to Sharia Muslim cannot finance or participate in any forbidden activities and an ethical investing is the only acceptable investing. In 1962 was founded Tabung Haji bank based on Sharia principles. Tabung Haji is one of the oldest Islamic banks nowadays.⁴

The Islamic way has gained considerable appeal for Muslims. After a number of decades of conventional banking, people in Muslim majority countries in the Gulf region, Asia and other parts of the world, demand for investment and financing possibilities that comply with their faith increased. This development gave rise to the current dynamic growth of the Islamic financial service industry. The Islamic bank and financial industry grew dynamically after two key institutions were established - the Islamic Development Bank and the Dubai Islamic Bank institutions.⁵ The Islamic Development Bank is an intergovernmental bank aimed at providing funds for development projects in its fifty-six member countries.⁶ The Islamic Development Bank gave momentum to the Islamic banking movement followed by private and governmental institutions and has been fostering the development of Sharia compliant financial instrument. The Dubai Islamic Bank is the first Islamic bank offering full service and products and is a fully fledged private Islamic bank. Both institutions play a major role in today's Islamic financial market. During the 1980's several other Islamic financial institutions as well as the first Islamic mutual funds emerged. The rapid growth of Islamic banking in Malaysia began after 1983 as part of government policy to improve the lives of the Muslim majority. In addition to this purely economic policy had domestic political reasons - though Muslims make up 75 percent of Malaysia's population, most of the private sectors in the capital controlled by ethnic Chinese. The Government of Mahathir Mohammad Mada trying, with some success, to attract capital into the country from Middle East in order to make Kuala Lumpur the center of Islamic finance in Southeast Asia.

In 2004 opened the first Europe's Islamic bank in London . The banks in Switzerland and the Netherlands in 2006, and the Bank of Italy (2007) followed it. Since 2008 the “revival”, which spilled over into an active discussion of plans for the establishment of Islamic banks in Sweden, France and Germany. Today there are nearly 200 Islamic banks and many other Islamic non-banking financial institutions.

The market started to grow in 1990, by attracting the attention of public lawmakers and institutions interested in introducing innovative products. Accounting and Auditing Organization for Islamic Financial institution (AAOIFI) was established in Bahrain to highlight the special regulatory needs of Islamic financial institutions. Islamic insurance (Takaful) is introduced, Islamic equity Funds are also established (Greuning and Iqbal, 2008).

In the millennium, the Islamic financial services institution is formed to oversee corporate governance issues and make the regulations of the Islamic financial market. The banking industry has witnessed intensive competition in the market by offering innovative products and unique services. As a result, Islamic assets have grown between 15 per cent to 20 per cent annually for the past five years, which makes Islamic banking one of fastest- growing sector in the global financial services industry (Booz & Company 2008). The following graph illustrates the growth of Islamic banking industry, by the end of 2008, it is estimated the total assets could reach US$ 500 billion.

(Source Booz & Company 2008)



3.2 Characteristics of the Islamic financial system

3.2.1 Prohibition of interest

Islamic banking system totally differs from conventional bank. They do not deal with an interest. It's prohibited by Sharia law which is derived from Holy Qur'an. “Riba is prohibited step by step by Allah Almighty by conveying its pros and cons in the Sura-e-Rome (30:39) and finally declared haraam in the Sura-e-Al-Bakara (2:275)”. Following verses of the Holy Quran clearly reflects the instructions regarding riba. Riba (surplus) is prohibited in Islamic finance which is defined as any unjustifiable increase of capital on loan or when transaction is occurred. In other words, any pre-determined rate, depending on the timing and amount of the loan, which is invested in order to make money, is called riba and prohibited. Most of the Islamic scholars defined the term riba is not only high, usurious, but any kind of interest accruing. Such a ban is justified by notions of social justice, equality and the rights of property. Islam encourages a profit, but condemns the use of percentage for profit, as these activities do not lead to the creation of the product and may not increase the welfare of society. Social justice requires that borrowers and lenders received honoraria or loss on a parity basis, and that the process of accumulation and wealth creation in the economy reflects the real contribution of economic agents to economic development.

3.2.2 Profit Loss Sharing (PLS)

In Islamic banking system because of prohibition interest charge, who offer money in debt, become an investor instead of creditors. The owner of the financial capital and the entrepreneur share the risks in order to share the benefits. The idea of PLS is all profit and losses from physical investment should be shared between lender and the borrower in respective level of participation.



3.2.3 Money as “potential” capital

Money become a real capital only when invested in productive activities. Prohibition of speculative behavior “meysir”, in the Islamic financial system accumulation of money in a big amount is not approved as well prohibited activities characterized by great uncertainty (ex. Gambling). Due to the existence of “meysir” in the Islamic financial system is extremely complicated distribution of derivative financial instruments, transactions with a significant inherent risk. Sanctity of contracts. Islam preaches the performance of contractual obligations as the most important duty of parties to the transaction. These requirements are intended to reduce the risk associated with asymmetric information and moral hazard. Additionally, Islam condemns gaining unilateral advantages of a more informed party of contract.¹ Therefore imposed a ban on ghatar - the deliberate risk goes beyond the inevitable accident. In general, the concept of “ghatar” gets any speculative transaction.

3.2.4 Islamic banks are a critical element of the Islamic financial system

In the Islamic model, bank's function is the same as conventional bank, western: provide work of the national payment system and act as financial intermediaries. In national payment, system there is no difference between these banks, but about a financial intermediary, there is a fundamental difference. A key moment in which Islamic banks are different from Western financial institutions is that they do not use in their practices bonus as a percentage of payment. Islam as noted does not condemn making a profit; it prohibits the fixed amount of payment as in conventional banks. According to the norms of Islamic ethics is right only the wealth, which is gain by your own work and the entrepreneurial efforts of its owner, as well as an inheritance or gift. In addition, the profit is the reward for the risk associated with any business company.² The bank may receive income without charging interest, if he is a member of the project. The bank must be completely separate from the enterprise both profits and risks. In addition, the bank may engage in trade and make profit from the margin between the cost of acquisition of goods and the cost of its implementation. In this case, only the actual results of operations, and to advance predetermined interest rate will affect the profit of the bank.

According to Sharia law prohibits financing trade operations related to certain products: tobacco, alcohol, weapons, as well as the proliferation of pornography, gambling etc. ³

Thus, the principles of Islamic banks does not contradict the principles of the market economy, and, abandoning the charging of interest, work on charitable basis they seek. It should be note that in the world exist as individual financial institutions that operate on the principles of Islamic religious ethics in the ordinary course of the financial system, and the whole country, the financial systems are based on the norms and laws of Sharia. In this case, every Islamic financial institution necessarily religious advisors that make up the Sharia Supervisory Board. The functions of this body are acceptable certification of financial instruments, the calculation and payment of zakat⁴, checking bank transactions for compliance shariat⁵, as well as recommendations on the distribution of income and expenses between the investors and the bank. There are also centralized bodies monitoring compliance of the norms of Islamic bank shariah.⁶

3.2.5 Financial instruments used by Islamic banks

Here is the classification of contracts concluded by Islamic banks. They share them on transactional contracts related to the implementation of transactions and contracts in which the bank acts as a financial intermediary. Transactional contracts are relates to the production in the real sector and include trade, exchange and financing of economic activity. Mediation contracts facilitate efficiency transparency of transaction contracts. Realizing the function of a financial intermediary, the bank accumulates funds of depositors, and shall put them into assets that can generate income. The combination of transactional and intermediary contracts provides a set of financial instruments for the successful operation of the bank.

The basis of Islamic banking is the principle of participation by the owner of the funds in both the profit and loss account. That is the owner of the cash gets rewarded for providing the resources only if the funded project is profitable. At the same time, the principle of participation in profit and loss statement is not used in a card-type contracts, al-Hasan, muadћal Bai, Bai Salam and murabaha, Ijara, which provide funding for the purchase of goods. These tools are closely associated with the adoption of risk and are not very different from those used for conventional banks. islamic banking financial

Thus, Islamic banks offer a wide range of financial instruments for financial transactions. the main financial instruments, which is based on Islamic financial system, are described below.

Musharaka

Musharaka is a joint project of the bank and the entrepreneur. This product provides for the signing of the bank and the customer of the partnership agreement, under which the parties will jointly finance the project. If this is the agreement under which the bank pays to the customer at a pre-agreed proportion of the profits obtained because of business, or profits are divide between him and the bank in proportion to the participation of the parties in the financing of the project. Also, distribute the losses in proportion to the participation of the parties in finansirovanii10. Funding for the project may be more than two parties, and then the management of the project carried out by all parties involved, either one of them. The advantage of the product is that it allows the flexibility to enter into an agreement in which the parties may agree the peculiarities of the partnership, the shares in the distribution of income and forms of governance. In fact, the implementation of Musharaka is a bank portfolio investment in investment projects. Musharaka contracts uses to replenish working capital or for joint investment activities, such as investments in real estate and agriculture. Often this type of contract used to finance long-term investment projects.

1. The Bank and the client negotiate the terms of the transaction and conclude an agreement on the joint participation of (the business plan).

2. The Bank and the Customer is carried out by the relevant terms of the contract, financing (in specified proportions) of the business - plan.

3. As part of the business plan is the outcome of (profit or loss).

4. Profit generates funds for distribution; loss reduces the value of assets used to implement the business plan.

5. Profit (or loss) from the sale of the business plan, the relevant shares are distributed between the Bank and the Customer.

4. 

4. Mudaraba

In this type of contract the bank, the owner of capital, trust their money to their effective use of the entrepreneur who has the capacity, experience and reputation (mudarib). And the bank has no right to demand collateral in exchange for cash.Mudaraba is typically used to finance short-term and medium-term investment projects (eg in trade). Mudaraba contracts are similar trust fund in the traditional financial system.

The resulting income from the invested money is shared between the bank and the entrepreneur in accordance with the agreement made at the time of signing the contract. Moreover, the contract stipulates the proportion in which profits will be shared, and not the specific amount of money (usually a bank gets 15 - 30% of profits). Losses in the event of their occurrence is only the bank and mudarib in this case does not receive remuneration for their work and efforts. In the daily management of the project, the Bank does not intervene. However, the entrepreneur does not have the necessary permission from the bank to route received from the bank funds to finance other projects that are not covered by the contract, and can not attract other sources of funding, or to use their money. Costs entrepreneur limited his time and effort. However, if the negligence and mismanagement of the entrepreneur are proved, he will be responsible for financial losses.

Mudaraba contracts may include not only directly between the bank and the entrepreneur, but also among the depositors and the bank. In this case, the investor acts as a bank, and the bank - the entrepreneur.

It should be noted that due to the fact that the bank does not require collateral for funds, the risks are very high Mudaraba contracts and those contracts are not widely distributed.



1. The Bank and the Customer enter into an agreement on trust-based partnership (for the Client project), the Bank is providing funding to the Client.

2. The client manages the project.

3. As part of the project is the outcome of (profit or loss).

4. Profit generates cash funds for distribution, loss of assets reduces the cost of the project.

5. Profits from the sale of the project, the relevant shares are distributed between the Bank and the Customer.

6. Loss on realization of the project is the result of the Bank.

Murabaha under this contract, the Bank provides commercial financing. murabaha is accompanied by a contract of sale of goods between a Bank and its customer at an agreed price. Bank buys goods (raw materials, parts, etc.) on behalf of the client, and then pereprodaлt him the goods, getting profit from sales of goods, as well as a surcharge for services rendered. After signing the contract, the Bank shall provide the customer with the product, and the date and place of receipt of the goods stipulated in advance. before the goods are received by the client, all risks connected with a possible defect or damage, bears the bank.

The price of the goods shall be determined in advance, and must specify the value of the mark, which is the reward of the Bank. the client pays the required amount (usually gradually - in the form of an annuity payment) within a specified period of time, or sent at once. Additional charges for bank services can be specified in terms of money or as a percentage of the value of the goods, but should not in any way be related to the time (the expression "a week", "month", etc. are not allowed).

The guarantee for the Bank can serve as collateral, which he takes from the client. Deposits can be submitted both in cash and in the form of a mortgage; the Bank can receive it at the time of signing the contract or before.

1. the customer is identified with an asset and vendor of the asset.

2. the customer is drawn to the Bank for financing the purchase of the asset at a price of resale.

3. the Bank shall transfer the money to the provider.

4. the supplier provides asset ownership in the Bank.

5. the Bank on the basis of the transaction the client sells the asset acquired murabaha at a new price.

6. the customer makes payment for the purchased asset, taking into account the terms and conditions for installment (deferment) payment for the asset.



4.1 Bai salam

Under this contract, the buyer pays the seller beforehand stipulated cost of goods which the seller promises to deliver after a certain period of time. That is the contract involves the purchase of advance payment. Naturally, the goods must be allowed in terms of the Sharia law and Islamic countries.

Bai salam contracts may be concluded only if the goods are not owned by the seller at the time of the transaction. The purchaser may demand the pledge, mortgage or third party guarantee by the seller as an insurance policy against possible risks associated with incomplete delivery or the lack of it. Thus, prior to receipt of the product by the buyer risks shall be borne by the seller.

This tool is usually applied to such products, for which at the time of the conclusion of the contract, you can clearly identify the quantity, quality and specific characteristics. is found mainly in agricultural and other productive sectors.

1. The client enters into a transaction with the Bank of salaam to a specific asset, the current price of a future delivery date of the asset.

2. The Bank carries out an advance payment for the delivery of an asset at a bargain price salaam.

3. In certain date client supplies the Bank asset transaction salaam.

4. The bank sells the asset on the market at a price set by the Bank on the basis of market conditions.

5. The bank makes a profit from the sale of an asset in the market, expressed as the difference between the current price and the price of the transaction salaam with the Client.

4.2 Ijara

This product is similar to leasing in the traditional financial system. It provides for the agreement under which the Bank will first buy the equipment, real estate, etc. upon request, and then passes it to the client.

The duration of the lease and rent (fixed or changing in time) aligned parties.

Note that the traditional leasing costs of depreciation, insurance and taxes shall be borne by the tenant. the Ijara contract differs from a normal lease, as in entering into the contract that the lessor is the cost. However, Islamic banking, mechanisms exist which can shift such costs to the tenant.

Variant of Ijara contract, in which the Bank sells the right to use their property and income from it to your customer for medium-and long-term operations.

Ijara Ijara WA iktina by Al Thumm, Bai

These products is similar to the leasing contract, repurchase agreement in traditional banking. under these contracts, the client leases the property for a certain amount for a specific period. The client makes the payment in installments, which include rent, as well as part of the final price of the product. Upon the expiration of the lease of the property becomes the property of the client. the value of the property is determined at the conclusion of the contract and will not change over time.



1. The client is determined by the asset and the supplier of the asset.

2. The client applies to the Bank for the financing of an asset by the Client.

3. The bank transfers the funds to the Supplier.

4. The vendor provides asset owned by the Bank.

5. Bank based on Ijara transaction provides the Client assets acquired in the use of a fixed term.

6. Customer makes lease payments for the use asset.

7. At the end of the lease customer returns the asset to the Bank.

4.3 Takaful

The contract represents a kind of Islamic takaful insurance. Note that Islam prohibits insurance because when concluding the insurance contract the buyer pays in Exchange for periodic payments to receive compensation in case of damage. However, his appearance is probabilistic in nature, that is, the insurer can receive premiums without payment to the policyholder, and prohibited by Sharia.

However, the contract allows to exclude the presence of takaful Islam prohibited items (such as RIBA, gharar, mejsir), because it is based on the principles of mutual responsibility. Participants carry out monetary contributions, some of which goes into a special fund to compensate losses at insurance event occurrence. Proportions in which funds are determined by the insurance company. Another portion goes to investment, guided by the principle of the separation of profit and loss, with a view to profit.

All participants share profits and losses from the investment operations of the Fund. Usually for these purposes use either model or mudaraba Vikala combination. When you use the mudaraba insurance fund clients profit from its portion of the contribution only if the company's investments will bring profit and the amount of remuneration will depend on the size of the profit. Vikala model assumes that the profit obtained by the Fund, after deducting the administrative and operational costs, shared between investors and defined in advance for the year. Prize for the management of the Fund depends on the return on investment that provides incentives for management.

Takaful insurance can benefit both individuals and corporations.

4.4 Istisna

Istisna is a derivative that functions within the Islamic financial system. This banking product was created specifically to finance large-scale and lengthy projects. The calculations are carried out under such contract at a price fixed at the date of the agreement and payments are made at predetermined intervals during the project and after its completion.

One of the features of this type of financing - making a detailed schedule of works (due date, the amount, quality, etc.) and his strict adherence to the implementation. The client has the right to appoint a sub-contractor to perform the work - a third party. The parties may agree on the timing of payments, but the amount of the contract shall remain unchanged.

In practice, the operation of working is as follows:

* client calls to the bank with the draft of a new organization of production, construction or acquisition of the property at a certain price and a certain quality, and the bank is a clear description of the project, which is subject to the Islamic and Economic Assessment Panel;

* The bank agrees to (or refuse) to implement the project;

* The bank enters into an agreement with the manufacturer, or by the construction company who agree to execute the order within the specified period;

* The results of the customer or the bank shall, depending on the conditions of the contract;

* The client pays the service fee in accordance with the contract between them.

4.5 Sukuk

Since the ban on interest does not give the Islamic financial institutions to issue securities in the same form as in the west, in Islamic banking, a special type of bond - sukuk, the yield of which is related to the return on real assets. The bond issue sukuk is similar to the standard process of securitization, in which developed a mechanism to acquire the assets and create the opportunity to form financial obligations to them. Such financial liabilities are the property with the possibility of making a profit over a period of time when the risk and return of securities, depending on the related assets are passed on to the security holders (investors).

The main contract used in the process of securitization bonds Sukuk - is Mudaraba. Mudaraba contracts used to create organizations Special Purpose Mudaraba '(SPM) is similar to traditional Special Purpose Vehicle (SPV), which issue their own securities, and then finance investment projects of its founder. Naturally, the projects need to comply with Sharia.

Most of the sukuk, which are available today, based on two Islamic contracts. In one case, the contracts are used salaam, muadzhal buy or buy salaam. Sukuk bonds using such contracts (sukuk al-salam) are a convenient investment mechanism for short maturities, as the financing of the goods usually short-term, ranging from three months to a year. However, because the sukuk - this is a purely financial securities, the sharia considers them as debt. Consequently, many investors in Islamic countries can not trade in sukuk bonds in the secondary market, as there may be a riba. Because of this restriction, investors tend to hold such bonds until the maturity date.

The second type of bond is based on contracts Ijara (Sukuk Al Ijara), which are used for the issuance of securities with longer maturities. Ijara contract is most similar to conventional finance leases and allows for flexible benefits of both fixed and floating rates.



5. The structure of the Islamic financial system

The Islamic financial system includes the following institutions.

1. Islamic banks are financial institutions that accept deposits and carrying out investment of accumulated funds. Note that this group into full-fledged Islamic banking and Islamic banking subsidiary units or "window" of conventional banks.

2. Islamic financial institutions that are not banks. These include Islamic leasing and factoring companies, financial companies, housing cooperatives, microfinance institutions, private equity and venture capital funds, as well as the institutions associated with the performance of religious ceremonies and charity.

3. The Islamic insurance (takaful).

4. The Islamic capital market and its participants, such as brokerage houses, investment banks, etc.

5. Islamic financial infrastructure, which includes:

*Payment system;

* Screening systems, trading and clearing systems, Internet business infrastructure;

* To promote economic security and the maintenance of liquidity;

* Regulatory bodies;

* The authorities exercising control over compliance with accounting standards;

* rating agencies;

* Providers of statistical information;

* Educational institutions;

* Research organizations.

5.1 Islamic Bank balance models

In the Islamic banking system, there are two basic models for attracting and investing. The first model is the so-called bilateral Mudaraba, in which all funds are invested on the basis of the principle of the separation of profit and loss among investors, banks and borrowers. The liabilities include deposits of depositors in the Bank's balance sheet in the form of Mudaraba. From the assets of the Bank, in turn, uses the Mudaraba contracts with agents and entrepreneurs who need money for investments. In addition, the Bank may issue short-term interest-free loans (card-al-Hasan).

Another common pattern in the Islamic banking system is a two-piece model. Using this model, the liabilities of the Bank are divided into two parts: one includes demand deposits (which guaranteed income) and another investment deposits. Is considered that demand deposits 20

Owned by depositors during the entire duration of the contract and, therefore, banks should build up reserves for possible losses (in accounting terms) on such deposits. At the same time, the investment deposits helps finance risky projects with the participation of investors. They are not provided with the Bank and do not apply to reserve requirements.

ASSET Liabilities

Commercial banking	Asset backed financing (trade finance; operations provided by Keystone) Syndicated loans (mudaraba, musharika) Paid services (dћuala, Kard-al-Hasan)	Demand deposits (Amana) Savings accounts (Al-Wadia) Investment accounts (mudaraba) Special investment accounts (mudaraba, musharika)	Commercial banking
Corporate and investment bank			Investment bank
		Capital

Figure # :A model of Islamic bank balance

In an Islamic bank can open a checking, savings, investment or special investment account. Conditions for current accounts of Islamic banks do not differ from the conditions for opening such accounts in Western banks. Interest on current account is not paid, the customer at any time guaranteed repayment.

The owner of a savings account, has no right to participate in profits, but the bank in order to attract investors may pay a premium, depending on their profitability. Savings deposit is not urgent, but the main part of his return is guaranteed by the bank. Funds raised on savings deposits, the bank is trying to invest in low risk surgery, usually in the financing of commercial transactions.

There are limited and unlimited investment accounts. Manage Restricted investment accounts similar to mutual funds management, and they can not be considered as a source of bank funds. Grace and Iqbal suggest that most of the Islamic banks' liabilities consist of contracts on the basis of the principle of Mudaraba. There are several variants of such contracts with a repayment period is stipulated in advance. This contract is based on the principle of participation in profit and loss account. Income derived by investors, as a rule, is comparable to the percentage in conventional banks. However, the income is not guaranteed, as the main part of the deposit. Islamic banks are often combined depositors' funds with his own, and then forward them to the investment, the profits of which are distributed among the depositors and the bank. In this case, the bank there is a problem of distribution of profit, especially if there are different types of investment accounts.

In addition, an Islamic bank can open a special investment account (unrestricted investment account), which allows the investor to choose the direction of investment of their funds. Maturity and the distribution of profits is negotiated separately for each special investment account. Holders of unrestricted investment accounts provide the bank complete freedom in the use of their funds, provided that the placement of money does not violate the principles of Sharia.

On the part of the Islamic bank assets has a large selection of options to invest. Short-term investments with limited risk can be made through contracts such as Murabaha, muadzhal buy, buy salaam. These tools enable the bank to provide short-term loans to its customers. In this short period of repayment and security of real assets to minimize risks.

Medium-term investments are based on contracts and istisna Ijara, which also provided a real asset. These tools may have characteristics similar to both floating and fixed interest rates for ordinary operations of banks. Thus, this part of the assets actually is an investment fund that invests in other investment funds to balance the Mudaraba contracts by the obligations. Investments in venture capital or private equity funds can be implemented using Musharaka contract.

Thus, the numerous contracts that are assessed in the Islamic financial system, allow Islamic banks to carry out the full range of traditional banking. In addition, at first glance, because of lower riskiness of their operations and the high degree of security contracts, real assets, Islamic banks need to be more stable than traditional ones. At the same time, we should not forget that Islamic lenders also face certain risks. We consider these in more detail.

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