The Basics of Islamic

Banking & Finance

A Dubai Bank Publication

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 Authored by;
Copyright © 2006
All rights reserved. The rights of the authors as Aisha Al Shamsi
identified have been asserted by them in Fadi Matar
accordance with the Copyright, Designs and
Patents Act, 1988. Ahmed Al Saidi
Saman Raza
The contents of this document have been scripted
to the best of knowledge by the authors.
Definitions and interpretations of some of the
terms may differ from other sources. Non of the
authors or editors may be held responsible for
any errors or misinterpretations. Design and layout by Fadi Matar

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 INDEX
Islamic Banking Principles
Q&A

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What is ISLAMIC BANKING
The Principles

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WHAT IS ISLAMIC BANKING?

™ Islamic banking refers to a system of banking or banking activity which is consistent with Islamic
law (Sharia) principles and guided by Islamic economics.

™ In particular, Islamic law prohibits the collection and payment of interest, also commonly called
riba in Islamic discourse.

™ Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of
gambling).

™ In addition, Islamic law prohibits paticipation in businesses that are considered either detrimental
or haram (such as businesses that sell tobacco, ammunition, alcohol or pork, or businesses that
produce un islamic media)

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The 3 key principles

™ Islamic banking is based on the Quranic prohibition of usury (riba)

™ Money cannot be used as a commodity or asset

™ Transactions must be asset backed

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FUNDAMENTALS OF ISLAMIC BANKING

™ The fundamentals of Islamic Banking are taken from Shari’a (Islamic Law)

™ The five essential principles on which Islamic banking is based consist of :

™ Prohibition on Interest (riba)

™ Prohibition of Uncertainty (gharar)
™ Prohibition on Speculation or gambling (maisir)
™ Restriction on activities/commodities e.g. Alcohol, Arms and Ammunition and Pork
™ Profit and loss sharing mechanism

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INTEREST (RIBA)

™ Paying or receiving of interest is forbidden as it is considered usury

™ Prohibition of a predetermined payment over and above the actual
amount received
™ Only non-interest loans (Qard-ul-hassan) are permissible by Shari’a

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UNCERTAINTY (GHARAR)

™ Prohibition of a contract based on the occurrence or the non-occurrence of a

future uncertain event
™ Counter-parties should have perfect knowledge of the values involved in the
transaction hence payment details should be pre-agreed
™ Contracts like Istisna’a and Salam which involve delivery of goods at a future
date have an element of uncertainty but are permissible by Shari’a

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SPECULATION (MAISIR)

™ Transactions purely undertaken for speculative purposes are prohibited

™ Trading or investment transactions that involve risk are permissible

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PROHIBITED ACTIVITIES / COMMODITIES

™ Dealing in certain commodities and activities are prohibited by Shari’a

™ Islamic banks, therefore, cannot finance enterprises that deal in the following activities/commodities
™ pork
™ tobacco
™ arms and ammunitions
™ cinema
™ interest-based financial services
™ gambling
™ liquor
™ pornography

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PROFIT AND LOSS SHARING

™ The provider of the capital must share in the profits and losses arising
from the underlying activity
™ The activity is permissible only if the provider of the capital accepts risks
in the activity
™ This concept encourages investments as the risk is shared by all parties
involved

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Conventional vs Islamic

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ISLAMIC VS CONVENTIONAL BANKING

™ The best-known feature of Islamic banking is the prohibition on interest. Islamic banking
aims to encourage risk sharing with higher returns for higher risk taking, with the notion
that high-risk investments provide a stimulus to the economy and encourage
entrepreneurs to maximize their efforts. The basic principle is to create a system of
equitable sharing of risk and rewards.
™ Islam encourages investments in order that the community may benefit. The shareholders
and depositors should all share the risks and the rewards of financing business ventures.
™ This is unlike the interest-based commercial banking system, where all the pressure is on
the borrower: to pay back his loan, with the agreed interest, regardless of the success or
failure of his venture.
™ Islamic banking helps to contribute towards a more equitable distribution of income and
wealth and increased equity participation in the economy.

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The main product types in Islamic Banks are:
• Mudaraba
• Murabaha
• Musharika
• Istisna’a
• Salam
• Ijara

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DEFINITION OF MUDARABA

™ A Mudaraba is a profit sharing partnership agreement in which the investor (the Rab-ul-mal)
provides the necessary finance, while the recipient of the funds (the Mudarib or the manager)
provides the professional, managerial and technical know-how towards carrying out the venture,
trade or service with an aim of earning profit.

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ISSUES

™ The Bank may enter into a Mudaraba contract in the following two ways:
1. As Mudarib – Where it manages the deposits of its account holders
2. As Rab ul Mal – Where it provides funds to its customer, an entrepreneur or asset manager

RAB-UL-MAL MUDARIB

DEPOSITS INVESTMENT ISLAMIC BANK

ACCOUNT HOLDERS

INVESTMENTS ISLAMIC BANK ASSET MANAGER

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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CHARACTERISTICS
The Bank as Mudarib
RAB-UL-MAL MUDARIB

DEPOSITS INVESTMENT
ACCOUNT HOLDERS ISLAMIC BANK

INVESTMENTS ISLAMIC BANK ASSET MANAGER

™ Profit from the Mudaraba activity is shared between the Bank (as Mudarib) and the investment account
holder (as Rab-ul-mal) in a pre-agreed ratio
™ The Bank does not bear any loss but remains responsible for any negligence
™ The Bank may receive from its investors compensation (Mudarib fees) in return for management of their funds
™ The Bank is bound to return the capital to the investors after deducting any losses or Mudarib fees at the time
of winding up of the contract

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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CHARACTERISTICS
The Bank as the Rab-ul-mal
RAB-UL-MAL MUDARIB

DEPOSITS INVESTMENT
ACCOUNT HOLDERS ISLAMIC BANK

INVESTMENTS ISLAMIC BANK ASSET MANAGER

™ Profit from the Mudaraba activity is shared between the Bank (as Rab-ul-mal) and the Mudarib in a
pre-agreed ratio
™ The Bank will bear all the loss unless the Mudarib violates the agreement
™ The Bank will pay to the Mudarib, compensation (Mudarib fees) in return for management of its
funds
™ The Mudarib is bound to return the capital to the Bank after deducting any losses or Mudarib fees at
the completion of the contract

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

Investment /
RAB-UL-MAL MUDARIB trading
activities

™ Payment of Mudaraba capital to Mudarib

™ Mudarib engages in investment and/or trading activities
™ Mudarib pays Rab-ul-mal’s share of profit
™ Mudarib returns the Mudaraba capital to the Rab-ul-mal on liquidation of the contract

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ASSOCIATED RISKS

™ Investment Risks
Banks (as Rab-ul-mal) do not hold any “tangible” assets as security, but will not be liable for any losses
beyond the capital he has contributed
™ Operational Risks
Banks (as Rab-ul-mal) have a lower degree of control over the management of funds
™ Credit Risk
Risk of default due to poor credit standings, lack of experience or lack of commitment
™ Market Risk
Risk of price fluctuations especially if the Mudarib invests funds in securities. Also includes risk of currency
rate fluctuations

MUDARABA
MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF MURABAHA

Murabaha is a contract wherein the Islamic bank, upon request by the customer,
purchases the asset from a third party supplier/vendor and resells it to the customer
either against immediate payment or on a deferred payment basis i.e. Cost plus finance

MUDARABA MURABAHA
MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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CHARACTERISTICS

™ The Bank makes a profit on the difference between the vendor price and the price charged
to the customer
™ The profit margin is pre-determined by taking into account the period of financing, pattern
of disbursement, mode of repayment etc.
™ An advance payment (called Hamish Gedyyah) may be received from the customer as a
form of security, and will be held in trust on behalf of the customer until the agreement is
signed
™ The Bank’s purchase price for the asset is equivalent to the amount of financing to the
customer

MUDARABA MURABAHA
MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

VENDOR ISLAMIC BANK Agreement CUSTOMER

™ The customer approaches the Bank with the request for financing
™ The Bank purchases and receives title of ownership from the vendor
™ The Bank makes payment to the vendor
™ The Bank transfers the title over to the customer upon payment to the vendor (back-to-
back)
™ The customer makes payment up-front or on a deferred basis

MUDARABA MURABAHA
MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ASSOCIATED RISKS

™ Asset Risk
The customer may fail to purchase the asset from the Bank, thereby exposing the
Bank to Asset Risk
™ Credit Risk
Risk of default due to poor credit standings or lack of commitment

MUDARABA MURABAHA
MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF MUSHARIKA

™ Musharika
This is a type of partnership between the Bank and the customer whereby each
party contributes to the capital of the partnership in equal or varying proportions
either to establish a new venture or share in an existing one
™ Types of Musharika
– Permanent Musharika (Equity Participation)
– Diminishing Musharika (Long-term Musharika)
– Temporary Musharika (Working Capital Financing)

MUDARABA MURABAHA MUSHARIKA

MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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CHARACTERISTICS

™ Musharika agreements can be entered into for a short-term or long-term period

™ Profits and losses from the venture are shared by each Musharik in accordance
with the Musharika agreement

MUDARABA MURABAHA MUSHARIKA

MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

Profit Profit

Partnership/
Bank Musharaka CUSTOMER
Monetary Funds Down payment

™ The customer approaches the Bank with the request for financing
™ The Bank enters into a Musharika agreement with the customer
™ Specific role of the two parties in the management of the venture
™ Profit from the venture is distributed between the Bank and the customer

MUDARABA MURABAHA MUSHARIKA

MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ASSOCIATED RISKS

™ Operational Risks
– Banks have a lower degree of control over the management
– Lack of commitment and mismanagement of funds by the Musharika
™ Credit Risk
Risk of default due to poor credit standings, lack of experience or lack of
commitment

MUDARABA MURABAHA MUSHARIKA

MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF ISTISNA’A

Istisna’a is a sale agreement between the Bank as Al-sani (the seller) and the customer as Al-
mustasni (the ultimate purchaser) where by the Bank:
– based on the order from the customer
– undertakes to have manufactured or otherwise acquire the subject matter (Al-masnoo)
of the contract
– according to the specifications stipulated by the customer and,
– sells it to the customer for an agreed upon price and method of settlement whether
that may be in advance, by instalments or deferred to a specific future date

MUDARABA MURABAHA MUSHARIKA ISTISNA’A

ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF PARALLEL ISTISNA’A

™ Parallel Istisna’a
This refers to the second sales contract entered into by the Bank with a
subcontractor to fulfil its contractual obligations in the first contract (Istisna’a) to
the customer

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ISSUES

™ The Bank always enters into a parallel Istisna’a contract in order to satisfy its
contractual obligations towards the Istisna’a agreement with the customer

™ The Bank remains liable for the performance of the Istisna’a contract regardless of
whether a parallel Istisna’a exists

™ The subcontractor in the parallel contract has no direct relationship with the
customer in the first contract

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

CUSTOMER Istisna’a ISLAMIC BANK

Al-mustasni Agreement
Al-sani

Parallel
Istisna’a

ISLAMIC BANK Par. Istisna’a

CONTRACTOR
Al-mustasni Agreement
Al-sani

™ The customer approaches the Bank with the request for financing
™ The Bank enters into an Istisna’a agreement with the customer
™ The Bank enters into a Parallel Istisna’a agreement with the contractor

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

CUSTOMER Istisna’a ISLAMIC BANK

Al-mustasni Agreement
Al-sani

Parallel
™ The Bank (as Al-mustasni) receives Istisna’a
the goods from the Contractor (the
Al-sani) in the parallel Istisna’a
contract ISLAMIC BANK Par. Istisna’a
CONTRACTOR
™ The Bank makes payment for the Al-mustasni Agreement
Al-sani
goods to the Contractor
™ The customer (as Al-mustasni)
receives the goods from the Bank
(the Al-sani) in the first Istisna’a
contract
™ The customer makes payment for the
goods to the Bank

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ASSOCIATED RISKS

™ Investment Risks
– Customer has no recourse nor any contractual relationship with the actual contractor,
hence the Bank is prone to failure
– Bank has no or little control over the selection process of the contractor
™ Operational Risks
Banks have no control over the manufacturing process
™ Credit Risk
Risk of default due to poor credit standing or lack of commitment

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF BAI AL SALAM

™ Bai Al Salam
Bai Al Salam (also known as Salam) is a contract whereby the Bank (Al-muslam) makes a
lump sum payment to a seller (Al-muslam Ileihi) for a specifically defined commodity (Al-
muslam Fihi) which will be delivered in the future

™ Parallel Salam
This is a second Salam contract entered into by the Bank with the buyer for the sale of the
specifically defined commodity which is to be delivered to the buyer on a specified future
date for an agreed selling price. The buyer must be a third party and not related to the
original seller

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAISALAM

AL SALAM IJARA OTHERS

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ISSUES

™ The payment to the seller in the first contract is made at the initiation of the
contract, however the delivery of the commodity to the Bank is deferred to a future
date as agreed between the Bank and the seller

™ On delivery date, the Bank receives the commodity and resells it to the customer in
the parallel Salam contract

™ The execution of the parallel Salam contract is not contingent upon the receipt of
the commodity by the Bank under the first Salam contract

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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CHARACTERISTICS

™ The sale price of the commodity under the parallel Salam contract consists of:
Š cost incurred by the Bank, and
Š the profit margin
™ The sale by the Bank under parallel Salam can be either on cash or deferred
payment basis

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

SELLER Salam ISLAMIC BANK

Al-muslam Ileihi Agreement
Al-muslam

Parallel
Salam

ISLAMIC BANK Par. Salam

CUSTOMER
Al-muslam Ileihi Agreement
Al-muslam

™ The seller (Al- muslam Ileihi) approaches the Bank (Al-muslam) with the request for financing
™ The Bank enters into a Salam agreement with the seller
™ The Bank (Al-muslam Ileihi), then enters into a parallel Salam agreement with the customer
(Al-muslam)

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

SELLER Salam ISLAMIC BANK

Al-muslam Ileihi Agreement
Al-muslam

Parallel
Salam

ISLAMIC BANK Par. Salam

CUSTOMER
Al-muslam Ileihi Agreement
Al-muslam

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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MECHANICS

SELLER Salam
ISLAMIC BANK
Agreement
Al-muslam Ileihi Al-muslam

Parallel
Salam

™ The Bank makes payment to the seller for the

commodity to be received at a future date (in
ISLAMIC BANK Par. Salam CUSTOMER
the first Salam contract) Al-muslam Ileihi Agreement Al-muslam
™ The Bank receives commodity from the seller
at a future date (in the first Salam contract)
™ The customer (as Al-muslam) receives the
commodity from the Bank (the Al-muslam
Ileihi) in the parallel Salam contract
™ The customer makes payment for the
commodity to the Bank (in the parallel Salam
contract)

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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ASSOCIATED RISKS

™ Investment Risks
Customer has no recourse nor any contractual relationship with the seller
™ Operational Risks
Banks have no control over the production process
™ Credit Risk
Risk of default by the customer due to poor credit standings or lack of commitment

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

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DEFINITION OF IJARA

™ Ijara
– Ijara is an operating lease that allows ownership of the right to use an asset
in return for consideration
– The contract does not end with the transfer of the ownership of the asset

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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DEFINITION OF IJARA MUNTAHIA BITTAMLEEK

™ Ijara Muntahia Bittamleek (Hire Purchase)

– This is a lease that ends with the ownership of the asset
– There are several types of Ijara Muntahia Bittamleek. These are characterized
based on the method by which the ownership transfers to the user:
• For no consideration (through a gift)
• For token consideration
• For price specified in the lease
• For remaining amount (if lease is terminated before period)
• Gradual transfer

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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ISSUES

™ Ijara and Ijara Muntahia Bittamleek contracts have three major elements:
– a form
– two parties
– the object of the Ijara contract (usufruct)
™ The customer pays to the Bank rental fees in return for the use of the leased
asset
™ The ownership title of the asset passes on to the customer through one of the
methods mentioned under Ijara Muntahia Bittamleek, however the title
remains with the Bank at the end of the lease period under Ijara financing

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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MECHANICS

. .
VENDOR ISLAMIC BANK Agreement CUSTOMER

™ The customer approaches the Bank with the request for financing
™ The Bank purchases the item required for leasing and receives title of ownership from the
vendor
™ The Bank makes payment to the vendor

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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MECHANICS

. .
VENDOR ISLAMIC BANK Agreement CUSTOMER

™ The Bank leases the asset to the customer

™ The customer makes periodic payments as per the contract
™ The asset title transfers to the customer based on the method disclosed in the agreement

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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ASSOCIATED RISKS

™ Investment Risks
Banks may not have control over the quality of the asset, hence possibility of
rejection by the customer
™ Operational Risk
Maintenance and insurance issues
™ Credit Risk
Risk of default due to poor credit standings or lack of commitment

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA

IJARA OTHERS

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DEFINITION OF QARD UL HASAN

™ A Benevolent Loan
– The borrower is only obligated to pay back the principal amount of the loan
to the lender
– Such loans are usually made for special circumstances, such as education
loans, social development, etc

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

OTHERS
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DEFINITION OF RESTRICTED INVESTMENT ACCOUNTS

™ Restricted Investment Accounts

– Investment account holder imposes certain restrictions as to where, how
and for what purpose these funds are to be invested
– Funds may be invested on the basis of Mudaraba contract

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

OTHERS
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DEFINITION OF UNRESTRICTED INVESTMENT ACCOUNTS

™ Unrestricted Investment Accounts

– Investment account holder imposes no restrictions as to where, how and for
what purpose these funds are to be invested
– The Bank may invest these funds as it deems appropriate
– The Bank may commingle its own funds with the unrestricted investment
account funds for the purpose of investment
– Funds are invested on the basis of Mudaraba contract

MUDARABA MURABAHA MUSHARIKA ISTISNA’A BAI AL SALAM IJARA OTHERS

OTHERS
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Glossary of TERMS

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 GLOSSARY OF ISLAMIC FINANCIAL TERMS

™ Al-Ajr: Refers to commission, fees or wages charged for services.

™ Amana/Amanah: Trust.

™ Al-wadia: Resale of goods with a discount on the original stated cost.

™ Al-wakala: Absolute power of attorney.

™ Al-Rahn: An arrangement whereby a valuable asset is placed as collateral for a

debt. The collateral may be disposed off in the event of a default.

™ Awkaf/Awqaf: A religious foundation set up for the benefit of the poor.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Bai'muajjal: Deferred-payment sale.

™ Bai al-Dayn: Debt financing: the provision of financial resources required for
production, commerce and services by way of sale/purchase of trade documents
and papers. Bai al-Dayn is a short-term facility with a maturity of not more than a
year.

™ Bai al-salam: Pre-paid purchase.

™ Bai Bithaman Ajil: This contract refers to the sale of goods on a deferred payment
basis (like Murabaha).

™ Baitul mal: Treasury.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)
™ Fatwa: A religious decree.

™ Fiqh: Islamic jurisprudence. The science of the sharia. It is an important source

of Islamic economies.

™ Gharar: Lit: uncertainty, hazard, change or risk. Technically, sale of a thing which
is not present at hand, or the sale of a thing whose consequence or outcome is
not known, or a sale involving risk or hazard in which one dose not know
whether it will come to be or not.

™ Hadith: A hadith is a narration about the life of the Prophet (saas) or what he
approved - as opposed to his life itself, which is the Sunnah.

™ Halal: That which is permissible. The concept of Halal has spiritual overtones, In
islam there are activities, professions, contracts and transactions which are
explicitly prohibited (haram) by the Qur’an or the Sunnah.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Hajj: means pilgrimage to Mecca and other holy places. Hajj, the fifth pillar of
Islam, is a duty on every Muslim who is financially and physically able to carry it
out, at least once in his lifetime.

™ Hawala: is an informal value transfer system used primarily in the Middle East,
Africa and Asia. Its origins are not entirely clear, but it is believed to have been
used first in the financing of long-distance trade in the early medieval period on
trading routes such as the Silk Road, the Eastern Mediterranean and the Indian
Ocean.

™ Hibah (Gift)

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Ijara: Lit: letting on lease. Technically, sale of a definite usufruct in exchange for a
definite reward. Commonly used for rentals, it also refers to a contract of land
lease at a fixed (or Variable) rent payable in cash.
- Leasing is also a lawful method of earning income, according to Islamic law.
In this method, a real assets such a machine, a car, a ship, a house, can be
leased by one person (lessor) to the other (lessee) for a specific period
against a specific price. The benefit and cost of the each party are to be
clearly spelled out in the contract so as any ambiguity (Gharar) may be
avoided.
- Ijara Wa-Iqtina (Lease to Purchase): The same as ijara except the business
owner is committed to buying the equipment at the end of the lease period.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Istisna’a (Progressive Financing): A contract of acquisition of goods by

specification or order where the price is paid progressively in accordance with the
progress of a job. An example would be for the purchase of a house to be
constructed, payments are made to the developer or builder according to the stage
of work completed. This type of financing along with bai salam are used as
purchasing mechanisms, and murabaha and bai muajjal are for financing sales.

™ Ju'alal: Lit: stipulated price for performing any service. Technically applied in the
model of Islamic banking by some. Bank charges and commission have been
interpreted to be ju'ala by the jurists and thus considered lawful.

™ Nisab: Exemption limit for the payment of zakah. It is different for different types
of wealth.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Qard al hasan
A virtuous loan. A loan with the stipulation to return the principal sum in the future
without any increase. Usually given for either welfare purposes or for fulfilling short-
term funding requirements.

™ Qard:
Qard is a loan, free of profit. This arrangement is used for Bank Current Accounts. In
essence, it means that your Current Account is a loan to the bank, which is used by
the bank for investment and other purposes. Obviously it has to be paid back to you,
in full, on demand.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Riba
This term literally means an increase or addition. Technically it denotes
any increase or advantage obtained by the lender as a condition of the
loan. Any risk-free or "guaranteed" rate of return on a loan or
investment is riba. Riba, in all forms, is prohibited in Islam.

™ Rabbul-mal: owner of capital.

™ Sadaqah: Charitable giving.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Shari’a: Islamic cannon law derived from 3 sources: the Quran; the Hadith
(sayings of the Prophet Muhammad); and the Sunnah (practice and
traditions of the Prophet Muhammad).

™ Shirkah: A contract between two or more persons who launch a business or

financial enterprise to make profit, also known as Musharika

™ Tawarruq or Reverse Murabahah. As used in personal financing, a customer

with a genuine need buys something on credit from the bank on a deferred
payment basis and then immediately resells it for cash to a third party. In
this way, the customer can obtain cash without taking an interest-based
loan.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Takaful: Mutual support which is the basis of the concept of insurance or

solidarity among Muslims.

This is a form of Islamic insurance based on the Quranic principle of Ta'awon or

mutual assistance. It provides mutual protection of assets and property and
offers joint risk sharing in the event of a loss by one of its members. Takaful is
similar to mutual insurance in that members are the insurers as well as the
insured. Conventional insurance is prohibited in Islam because its dealings
contain several haram elements including gharar and riba, as mentioned
above.

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GLOSSARY OF ISLAMIC FINANCIAL TERMS (CONT.)

™ Wadiah (Safekeeping)
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person
deposits funds in the bank and the bank guarantees refund of the entire
amount of the deposit, or any part of the outstanding amount, when the
depositor demands it. The depositor, at the bank's discretion, may be
rewarded with a 'hibah' (gift) as a form of appreciation for the use of funds
by the bank.

™ Zakah/Zakat: A tax which is prescribed by Islam on all persons having

wealth above an exemption limit at a rate fixed by the Shariah. According
to the Islamic belief Zakah purifies wealth and souls. The objective is to
take away a part of the wealth of the well-to-do and to distribute it among
the poor and the needy. It is levied on cash, cattle, agricultural produce,
minerals, capital invested in industry, and business etc. The distribution of
Zakah fund has been laid down in the Qur'an (9:60) Zakah is the third
pillar of Islam. It is an obligatory contribution which every well-off Muslim
is required to pay to the Islamic state, in the absence of which individuals
are required to distribute the Zakah among the poor and the needy as
prescribed by the Shari’a.

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For a more detailed presentation or
additional material pertaining to Islamic Banking
and Finance, please contact Fadi Matar on 04 3178123 /
fadimatar@dubaibank.ae

64
Q&A – Dubai Bank

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Q&A

• What is Islamic banking?

• Islamic banking refers to a specific type of ethical investing or banking. It prohibits the
use of money as a commodity and therefore outlaws usury or riba. All transactions need
to be asset backed.
• The five essential principles on which Islamic banking is based consist of:
– Prohibition on Interest (riba)
– Prohibition of Uncertainty (gharar)
– Prohibition on Speculation or gambling (maisir)
– Restriction on activities/commodities e.g. Alcohol, Arms and Ammunition and Pork
are prohibited activities
– Profit and loss sharing mechanism to equitably share the risks and rewards of a
transaction
• What is the difference between conventional and Islamic banking?
• As explained above – the prohibition on usury and the requirement for transactions to be
asset backed are key differences between Islamic and conventional banking. [In Islamic
Banking you take a profit, whereas the conventional system refers to it as interest].

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Q&A
• Why are we going Islamic?
• Islamic Banking is going through a significant growth phase in the region and the
products & services on offer require major improvement. From a longer term strategic
perspective, we will grow in the Islamic finance arena at a much faster pace than our
competition as we feel we are well positioned to deliver superior and innovative
products & services. In addition, conversion will allow us to focus and nurture the
Bank’s geographical expansion regionally and internationally.
• In view of the above, the Bank’s Board of Directors and Owners have decided to enter
the Islamic Finance arena in order to deliver innovative solutions that will permit
Dubai Bank to grow into one of the largest Banks, not only in the country but also in
the region.
• Why does the bank want to restrict its areas of activity?
• The Bank is not intending to restrict its areas of activity. On the contrary, with a new
focus on Islamic banking, Dubai Bank intends to bring about an expansion of the
services, products and activities that it currently is involved in. The only difference will
be that these services, products and activities will be Shari’a compliant.

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Q&A
• Why doesn't the bank want to do what most other conventional banks are doing, i.e.
have an Islamic window?
• We believe that doing business on both the conventional and Islamic sides of the banking
sectors will not be focused enough and thus not allow a true impact on the Islamic
banking sector. To function in both business areas, Dubai Bank will likely remain a small
conventional bank with some Shari’a compliant products. This will in no way properly
distinguish it from any other local bank. However, if we set out in a focused manner to
make Dubai Bank a dynamic Islamic alternative, with the objective of continuing to
deliver superior products and services to market, we will make a far stronger impact on
our selected business area.
• When will the conversion take place?
• We are targeting the first quarter of 2007.
• How long will the process of conversion take?
• The conversion process will take a year or so. A lot of preparatory work has already been
done.
• Which businesses will stay and which will go?
• Dubai Bank aims to offer a complete array of financial services. This means that we will
continue to offer retail and merchant banking services.
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Q&A
• What will happen to existing businesses?
– Corporate
• Corporate Banking is one of the largest business segments for Islamic Banks
especially in contract financing, project finance, Asset Finance and trade finance
areas. Majority of the products offered currently by Corporate Banking can be offered
in Islamic Banking. The product team for Islamic Banking will be reviewing the
Islamic versions of the products to ensure that a complete suite of products are
available for the Bank’s existing customer base as well. For instance, the product
team has already identified a solution for the Bank’s FI portfolio, allowing the Bank
to continue investment in this medium return low risk business.
– Retail
• The retail products, including Auto Loans and Personal Loans, have Islamic
counterparts / versions. Credit Cards are offered by ADIB, Emirates Islamic Bank, Al
Rajhi Bank, where the Banks charge processing fees for giving revolving facilities. The
product team will review the existing Islamic versions of the credit cards available
regionally / internationally and will endeavour to develop a product superior to
existing Islamic Credit Cards currently available. In addition, the Bank will get into
Mortgage Finance business, the market for which has grown significantly in the last
couple of years.
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Q&A

– Treasury
• Currently, the Islamic Banks are not allowed to trade in derivatives / hedge funds or
interest bearing papers. However, Islamic Finance as an industry is in its infancy and
in our opinion, alternatives to these products will eventually be available. Developing
such effective counterparts to existing products will give the Bank a competitive edge.
In addition, there is a significant gap in the liquidity management solutions available
to Islamic Banks. The Bank’s Treasury will work towards identifying solutions to such
gaps and certain ideas are already being considered.
– Investment Sales
• The Bank will not be able to sell structured notes paying interest. However, similar
structured products compliant with Shari’a principles are being developed by large
banks in Europe and in a few years it is likely that effective counterparts will be
available. However, the bank also wishes to establish a large Asset Management
business investing funds in products / businesses, which are Shari’a compliant.
Investment Sales in the Islamic Bank will be involved in distribution of third party
Islamic funds, in house managed / originated funds and the IPO’s etc.

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Q&A

• If Credit Cards do not exist, will there be a significant decrease in support staff
considering that Credit Cards earns the most and requires highest support?
• Islamic banks are increasingly beginning to offer Shari’a compliant versions of credit
cards that are not simple debit cards. Therefore, Dubai Bank will also strive to
develop its own solutions. In addition, there will be other products that will be
launched that currently do not exist in our conventional operations like mortgages
that will require an equally extensive support infrastructure.
• What will happen to the Credit Cards business when we go Islamic?
• Credit Cards are offered by a number of Islamic Banks and present a strong
proposition. Some of the benefits on our current product will have to change and the
fees will have to be amended. We are currently working on developing the product
manuals under the Islamic structure in order to develop the complete retail strategy
from a product offering point of view. We hope to have a clearer plan by the second
quarter this year, which will be shared with you. In the meantime, it’s business as
usual.

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Q&A

• What are the products in an Islamic Bank and will these products require complex
MIS as in Conventional Banking?
• The product offering in the Islamic Bank will be more than that of a Conventional
Bank. However, certain products adversely affected in the short term will be
Investment Sales and Treasury Sales. MIS requirements will be more complex in
Islamic Banking.
• Will there be a significant impact on Bank’s costs due to conversion, impacting
increments / incentive to staff?
• Employees’ salaries, allowances and bonuses will not be negatively affected as a
result of the conversion. A budget has been allocated for the conversion and this is
completely separate from the payroll and system of performance bonuses
administered by HR.

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Q&A
• What is the bank's strategy going forward?
• The bank’s overall strategy going forward will be as follows:
• Offer all products in Commercial and Investment Banking businesses; with focused target
products for each customer segment.
• Identify existing gaps in the Islamic Finance industry and develop product solutions to
address the industry’s requirements ensuring quick successes for the Bank.
• Offer superior and innovative products to those delivered by other Islamic Banks with the
value proposition to be at least similar to Conventional Banks, if not more.
• Geographically export the Islamic Banking model regionally and internationally in 5 to 10
years.
• Target markets to include developing economies (GCC, Levant, North Africa, Central Asia, CIS,
South East Asia and the Indian Subcontinent) rather than developed economies.
• Build up Capital Markets / Funds Management / Corporate Finance businesses to take
advantage of the economic boom and developing capital markets in the region.
• Offer excellent growth prospects to key performing employees of the Bank and to be perceived
as a Modern Islamic Financial Institution in line with Dubai’s brand image.
• The above strategy does not include the opportunities that may arise due to the Bank being
majority owned by Dubai Holding.
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Q&A
• Will my career be affected in anyway?
• Yes, positively. It is a fact that Islamic banking is a boom area. It is also a fact that
many of the best people in this field are a) non-Muslims and b) committed to Islamic
banking for business, not ideological reasons. Finally, it is a fact that candidates with
experience in Islamic banking can command higher salaries than those from a
conventional banking background as a result of supply and demand. Some
employees may not wish to stay in Islamic banking because they feel that this would
be detrimental to their careers but these will be personal decisions.
• I am not a Muslim? Will I lose my job?
• No. Islamic institutions are run by people of all religions.
• Would the branch concept change from selling point to service point?
• Our delivery channels will remain pretty much the same. We will however look to
enhance our on-line capabilities. Branches will continue to be the key channels and
we will be adding more locations as we progress with our expansion plans.
• Will the number of staff decrease?
• No. It will continue to increase as we add new businesses and expand our current
operations.
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Q&A
• Will there be a separate branch / section for ladies?
• This is something that will be considered however, it remains to be an option.
• What will be the working hours?
• The working hours will remain the same. Islamic Banking does not affect work
timings.
• Will the organisational chart change?
• Yes. The organizational chart will change to cater for the new business lines as well as
new products and services.
• Will the work environment be considerably more conservative?
• The bank will continue to promote a great working environment. No, the environment
will not become more conservative, it will remain as it is, however, the front end staff
may have to adhere to some minor dress codes.
• What will happen to my existing auto loan?
• The loan will continue. The only change will be at the back end, i.e. on our
accounting procedures.

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Q&A
• What will happen to my existing personal loan?
• Same as above. To add to both points, once the loan period is over, all new loans will be issued under
the Islamic principles.
• My credit card has an outstanding amount that I roll over monthly. What will happen to this?
• We are still studying a number of viable options to manage this process.
• Can non-Muslims work in customer facing roles and in back office roles?
• There is no prohibition on non-Muslims performing any role, front or back office, in an Islamic
institution. There are many non-Muslims in prominent positions in Islamic institutions – e.g., CEOs of
Arab Banking Corporation’s Islamic Asset Management, and the European Islamic Investment Bank;
Chief Operating Officer of Tamweel; Head of Corporate Banking in Sharjah Islamic Bank. Also, non-
Islamic institutions such as Deutsche, HSBC and Citibank are often at the cutting edge of new product
innovations that are developed by non-Muslims whilst many prominent legal firms have non-Muslims
heading their Islamic banking practices.
• In addition, Dubai Bank wants to appeal to mainstream customers and does not wish to project a
highly conservative image, rather a moderate yet Shari’ah compliant one. This is especially important
as the Bank has regional ambitions in exporting its business model. In a cosmopolitan environment
like Dubai, the moderate Malaysian approach to Islamic banking is more applicable where the majority
of clients are non- Muslim and would be served by multicultural employees that are reflective of the
society.

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Q&A
• Do non-Muslims have a career in the bank over the medium term?
• Yes. See previous question.
• What will be the longer term career impact of working for an Islamic Bank, if the staff
wishes to move back home or immigrate to another country in the medium term?
• It depends. Quite apart from the issue of Islamic banking, many employers in the
West do not value experience gained in the Middle East as valid as that gained in the
West. Rightly or wrongly, this is a fact. What is true, and something that any
recruitment consultant would confirm, is that getting a job in the West depends on
having marketable skills and qualifications and also on how these are presented by a
candidate to a prospective employer. Because there is very little difference between
the core functions of Islamic and conventional banks, in real terms, there would be no
impact on the career profile of the average employee.
• Will working for an Islamic Bank impact a candidate’s prospects with a conventional
bank in the region in the medium term?
• Not at all. Conventional bankers understand the complexities of Islamic banking and
know that the experience gained is invaluable.

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Q&A

• What will the dress code be? Will make-up be permitted?

• At this stage, we do not know but our working assumption is that there will be very
little change except in some branches (e.g. Sharjah) where ladies might be required
to cover their hair.
• I know nothing about Islamic banking? How will I learn?
• HR is currently organizing training courses for all staff. The bank will ensure that you
are fully trained and capable to manage all aspects of your job with respect to the
conversion.
• When will training commence?
• Training has already commenced for some groups and it will continue for the next 6
months or so.

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Q&A

• Would Muslim staff be better at selling than non-Muslims as Muslim’s might have
the product knowledge?
• Not necessarily. It is not about your religion, it is about how much you know. All
products will be attested by the Shari’a which means that the customer will already
have extended his trust in the Islamic element; it is up to ones sales skill to close the
sale.
• There are other questions that I need answers to. Is there a help desk I can call at
anytime for clarification?
• Yes. You may call Fadi Matar on 04 3178 123 or e-mail him for any clarification.
Your questions will be treated with the strictest confidence and privacy.
• Additionally, you may refer to the Intranet [Share-point] - Islamic Banking file.

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