CHAPTER 7: Practices Of Financing In IFIs

FINANCING MANAGEMENTISLAMIC

INTRODUCTION

•Finance is a science of money management•Also a field within economics that deals with the allocation of assets and liabilities over time under conditions of certainty and uncertainty•A key point in finance is the time value of money, ( one unit of currency today is worth more than one unit of currency tomorrow) aims to price assets based on their risk level and their expected rate of return. •Finance can be broken into three different sub-categories: public finance, corporate finance and personal finance.

Cont..

For islamic banking line,• Fund raised from people (workers, student, pensioners) and entrepreneurs

who save, besides other financial institutions and liabilities.• Then, use the sources of fund to finance people and entrepreneurs who need

it.• Finance various investment activities such as card service, trade financing,

money market and others which approved by shariah.• Example: Deposits from customers, for financing transaction such as house

financing and car financing• More than 75% of islamic banks fund obtain from deposits and the financing

transactions of most Islamic banks represent 50-80 % of the total Islamic bank assets

SHARIAH PRINCIPLES IN FINANCING PROCESS

Allah (God) is the owner of all wealth

Materials pursuits must be balanced with an individual’s spiritual needs.

An individual’s needs must be balanced with society’s needs

Economic transactions should take place within a just, responsible, free-market economy

Prohibited Business Transaction

Interest (Riba)

Uncertainty(Gharar)

Gambling (Maisir)

Prohibited products and industries

Financing Stages

Application goes to the Credit Department

(1) Prospecting or customer seeks financing.

(11) All litigation cases will be under the administration of the Recovery Department.

Credit Administration Officer:

(8) attends to the documentation and follow-up for the disbursement.

(9) once disbursed, the file and the duly registered documents will be transferred to Credit Administration / Documentation Department.

(10) Account will be monitored/placed under the supervision of the Credit Control Department when the customer is default.

Credit officer:

(2) scrutinize the application and credit worthiness of the prospect.

(3) attends to loan origination or Application Accommodation (A/A).

(4) evaluates the applicant.

(5) recommends approval or rejection of the application.

(6) The Authorized Credit Officer or Officer with Discretionary Lending Power will decide whether to reject

or approve.(7) Issuance of the Letter of Offer or

Letter of Rejection.

Modus operandi of BBA

(4) Sells the asset under PSA

(3) Purchases the qualified

asset

(1) Identify the asset

(2) Signing to purchase asset under PPA

(5) Pays the selling price by installments

o Islamic bank may finance the customer who wishes to acquire a given asset under a bank’s property purchase agreement (PPA). The bank will buy the asset from the developer.

o The bank would then sell the same property to the purchaser under a bank’s property sale agreement (PSA).

o The bank’s selling price of the property would include the bank’s profit margin as agreed to by the parties and its repayment is monthly installments of a specified sum over a certain period.

o As a security, the purchaser is required to execute a charge or an assignment of the property to the bank. Installments remain fixed over the period of the contract and no adjustment is made if interest rates fluctuate.

Modus operandi of Ijarah

(3) Leases the asset

(2) Purchases the asset

(4) Pays the financing via monthly rentals

(1) Identify the asset

o The bank is not a natural owner of the asset. It acquires ownership upon receiving a request from its customer.

o Ijarah rentals are paid in installments over time to cover the cost of the asset or value of investment for the bank plus a fair return on investment.

o Ownership of property is not transferred throughout the Ijarah period while the customer receives the benefits of using the asset.

o Risks associated with ownership of the asset remain with the bank and the asset is supposed to revert to the bank at the end of the Ijarah period.

Modus operandi of Mudharabah

30%

100%

Generates

Set up the business

Provides funds

70%

Profit

Loss

• One party, the Rab-Ul-Mal or financier, provides the capital, while the other party, the Mudarib, provides the entrepreneurship and effort to run the business.

• Profits derived from the business or investment are shared by the two parties according to a predetermined profit-sharing ratio (PSR). This could be, say, 70:30, or 80:20, with the larger portion accruing to the Mudarib.

• In the event of losses, the Shariah stipulates that all losses must be borne by the financier. Any party may terminate the Mudarabah agreement at any time. Finally, in a Mudarabah arrangement, the financier is not allowed to interfere in the running of the business.

Modus operandi of MusharakahLoss

Profit

Generates

30%

70%

60% 40%

Provide capital RM 6 million

Provide capital RM 4 million

Joint partnershipProfit Sharing Ratio 70:30

o Customer and bank discuss business plan and jointly contribute to capital of the venture.

o Customer and bank jointly set up the business venture and manage its operations, sharing the responsibilities as per pre-agreed terms as the business generates positive or negative profits.

o If the business generates profits, it will shared as a pre-agreed ratio.

o If the business suffer losses, the loss suffered by each partner must be exactly in the proportion to capital contributions.