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Current banking and financial system Essentials of Islamic Banking and Finance IQRA University Gulshan Campus IRSHAD AHMAD AIJAZ [email protected] Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1 Contents of the lecture Current financial and Banking System: – Economic system; – Financial Markets; – Financial intermediation; – Banking system; Possibility of Islamization of banking; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2 Contents Introduction; Economic system; – Sectors of economy; Financial Markets; – Components of financial markets; Financial intermediation; – Types of financial intermediaries; Banking system; – Role of banks in economy; – Interest based banking; – Qualities of banking system; Islamic bank – is it possible? Question and answers Essentials of Islamic Finance – IU Gulshan Campus, Slide # 3 Introduction Resources (natural or man-made) available to human being are limited but wants (desires) are not limited and everyone wants to achieve the best; Every person in a society has different types of wants and demands; – If A wants a cup of milk at a time then B may wants a piece of cloth at the same time and so on so forth; Management of these wants with in available resources is the art which is called economics; – So economics is an art of management of unlimited wants within limited resources. The system in which efforts are made to achieve these targets is called 'Economy'; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 4 Economic systems Any economy deals with issue of changing resources into products; The products either perform as mean to produce more products or a satisfactory mean to needs of human being; Three types of experiments in economics are there: – Market economy: An economy without almost any control on anything; – Planned economy: An economy with some controls put by the government; – Mixed economy: This economy is neither a full fledged free market nor it depends on pure planned economy; Under this concept an economy has mixture of freedom and planning; The first model of economy is famous with name of capitalism; The second one is known as socialism; The third one is known as mixed economy; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 5 Sectors of economy All types of economies focus on management of sectors of economy in different ways and methods; There are many theories belong to sectors of economy; The famous description is of 'five sector model'; A sector may be defined as a part of the economy where the participants are engaged in a similar type of economic activity; The five-sector model describes the operation of the economy and the linkages between the main sectors in the economy: – Individuals (Consumers); – Businesses (production and manufacturing); – Financial institutions (supply of money and finance); – Government (as a regulator – taxation and controlling function); – International Trade (the rest of the World); Essentials of Islamic Finance – IU Gulshan Campus, Slide # 6 Sectors of economy Individuals: – This sector consists of all individuals in the economy. These individuals are the owners of productive resources, and the consumers in our economy. – Individuals supply factors of production (inputs) such as labour and enterprise to businesses, which they use to produce goods and services. As a reward for supply resources such as labour and enterprise to firms, individuals receive incomes – rent, wages, interest and profit. Businesses: – This sector consists of all the business firms engaged in the production and distribution of goods and services (apart from financial services). It concerns all their activities involved with buying factors of production and using them to produce and sell goods and services; – Individuals and businesses are interdependent. Essentials of Islamic Finance – IU Gulshan Campus, Slide # 7 Sectors of economy Financial Institutions: – This sector consists of all those institutions that are engaged in the borrowing and lending of money, acting as the intermediaries between those who save, and borrowers of money. – Financial institutions are needed for individuals and firms to be able to undertake saving and investment. They perform the function of mobilizing savings for investment; Government: – The management of national needs and wants on macro level; – It is involved in the satisfaction of collection (community) wants; – It obtains the resources to do this through imposing taxes on the other sectors of the economy; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 8 Sectors of economy Essentials of Islamic Finance – IU Gulshan Campus, Slide # 9 Factors of economy There are four factors of economy according to capitalist approach; These are: – Land; Fixed assets that produce something; – Labour; Human capital; – Capital; Money and other forms of capital; – Entrepreneur; Owner and master; These factors produce 'products and services'; Every factor gets what is due to it; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 10 Economic System ECONOMY Factors of production Land Labor Capital Enterprise Products Goods Product Market Services Factor Market Essentials of Islamic Finance – IU Gulshan Campus, Slide # 11 Economic System Market activities determine the price. Demand and supply are the decisive factors for pricing; Both types of market have different norms and ways of operations; Product market Factor market Capital Loan Labor Manufactured goods Services Cloth Rental Food Health Shelter Education Employment Equity Financial Market Non-financial enterprises Essentials of Islamic Finance – IU Gulshan Campus, Slide # 12 Financial markets The market that deals in “financial assets” is called Financial Market; Asset means “any possession that has value in exchange”; So a Financial Market is a market where financial assets are exchanged; Assets Tangible Asset: Its value depends on particular physical properties Intangible Asset: It represent legal claims on some future benefits. Building Loan Machinery Share Land Bond Financial Assets Essentials of Islamic Finance – IU Gulshan Campus, Slide # 13 Classification of financial markets Classification by nature of claim: – Debt Market; – Equity Market; Classification by maturity of claim: – Money market – less than one year life market; – Capital market – greater than 1 year life market; Classification by seasoning of claim: – Primary market; – Secondary market; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 14 Financial intermediation; Financial intermediation is an act of institution, firm or individual who mediates between two or more parties in a financial context; Financial context means facilitating the channeling of funds between lenders and borrowers indirectly; The savers (lenders) give funds (deposit) to an institution (such as a bank), and that institution gives those funds to spenders (borrowers); Typically the first party is a provider of a product or service and the second party is a consumer or customer; This may be in the form of loans or mortgages; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 15 Financial intermediation Directly to these activities Individuals 1.Business 2.Industry 3.Individuals 4.Governments 5.Companies 6.International trade 7.etc. etc Companies Trusts Private Businesses Funds supply Supply of funds through Financial intermediaries Organizations 1.Banks 2.Insurance companies; 3.Credit unions; 4.Funds; 5.Investment trust; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 16 Financial intermediary and its types A financial intermediary is an institution, firm or individual who mediates between two or more parties in a financial context which means channeling of funds between lenders and borrowers indirectly; Following are its types: Financial intermediaries Depository institution 1.Banks; 2.Saving associations; 3.Loan associations; 4.Credit unions; 5.Credit societies; Non-depository institution 1.Development banks; 2.State banks; 3.Insurance companies; 4.Investment banks; 5.Brokerage houses; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 17 Role of banks in economy Exchange of financial assets on behalf of customers; Exchange of financial assets of their own assets; Receive deposits and provide safety; Provide investment device for market participants; Provide platform for small savers; Channelize idle wealth of society; Assist in settlement of claims; Provide cash management services; A tool for government for minatory control; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 18 Qualities of banking system Channelize idle wealth of society; – An individual can also participate in economy; Assist in settlement of claims; – Provide services for members of society; – Check and payment instruments; – Ease in payments; Provide cash management services; – No need for keeping books in home; A tool for government for minatory control; – Hoarding and inflation control; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 19 Conventional banking system STRUCTURE OF CONVENTIONAL BANK DEPOSITORS BANK CUSTOMERS Essentials of Islamic Finance – IU Gulshan Campus, Slide # 20 Interest based banking Receive deposit on interest; And give money on interest; Financial activities of a conventional bank LEND LEND DEPOSITORS CUSTOMERS BANK INTEREST INTEREST Essentials of Islamic Finance – IU Gulshan Campus, Slide # 21 Possibility of Islamization of banking system. Banks receive money from one side and give to other side; Any possibility for this in Islam? See nest slide: Essentials of Islamic Finance – IU Gulshan Campus, Slide # 22 Possibility of Islamization of banking system. STRUCTURE OF ISLAMIC BANK 1.Trade; 2.Rental; 3.Participation; 4.Investment agency Participate in business •Mudarabah; •Musharakah ISLAMIC BANK DEPOSITORS Share in profit CUSTOMERS 1.Profit in trade 2.Rent in rental; 3.Share in profit in participation; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 23 Problems and issues in existing financial system; Interest; Gambling; Excessive uncertainty; Non-Islamic business; No obedience to Islamic rules of business; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 24 Questions? Essentials of Islamic Finance – IU Gulshan Campus, Slide # 25