PROJECT REPORT: ISLAMIC
BANKING AND FINANCE
TOPIC:
SUBMITTED BY
ISLAM RAMEEN KHAN 2047173
IC ANUM IFTEKHAR 2047149
FINAN
SUBMITTED TO
CE SIR REHAN WAHEED
AND KARACHI, PAKISTAN
PRINCI 9TH-DEC-2022
PLES
TABLE OF CONTENT
OF
CHAPTER: 1 INTRODUCTION
CHAPTER 2: LITERATURE REVIEW
RESPO
CHAPTER 3: FINDINGS
CHAPTER 4: CONCLUSION
NSIBL
E 1
BANKI
NG
CHAPTER:01
INTRODUCTION
WHAT IS ISLAMIC BANKING?
Islamic financing also known as Islamic banking; refers to the financial activities based on Shar’iah
ruling. Two basic fundamental principles of Islamic finance are sharing profit and loss and not charging
Riba(interest) against any loan. Islamic banks use equity participation in which means is a business has
taken a loan from the bank so instead of paying with interest give the bank a share in its profits. Or by any
chance there’s a loss in the business then Islamic bank will also bear the loss. Islamic banking is more
risk averse compare to conventional banking as risk is shared and loss bearing is also done by both the
parties. Whereas, in conventional banking risk isn’t shared as it doesn’t matter whether business had a
loss or profit they still have to pay back the loan with interest payments in both the cases.
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There are some profit loss sharing financing products in which Islamic bank engages and these
encourages economic growth in the economy, one of them is Musharakah, it is known as the most
authentic form of Islamic financing, basically, it is a contract of joint partnership where partners invest in
the business or to finance a project or own real estate or movable assets, it can be permanent or
diminishing basis. Rights are given to musharakah partners to take part in management; they seem to bear
the greatest risk among all Islamic financing modes with the potential for earning the highest reward.
Ratios for profit sharing are pre-determined and losses are shared according to partner’s proportional
capital contribution.
On the other hand, Mudârabah is a profit-sharing and loss-bearing contract where one party supplies
funding (financier as principal) and the other provides effort and management expertise known as
mudarib with a view to generating a profit. By mutual agreement profit sharing is determined but losses,
if any, are borne entirely by the financier, unless they result from the mudarib’s negligence, misconduct,
or breach of contract terms then the loss will be shared by the mudarib. Sometimes mudarabah is also
known as sleeping partners because the mudarib runs the business and the financier cannot interfere in
management, though conditions may be specified to ensure better management of capital.
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Moreover, there are some non-profit/loss sharing contracts too in which Islamic banking engages, there
purpose is to provide finance to consumers and corporate credit, also focuses on asset rental and
manufacturing. One of them is mudarabah, in which bank purchases the assets and deliver them to the
clients at the particular date decided by both the parties to just facilitate the acquisition of goods for
customers. Also when the contract is signed the amount financed cannot be increased if the payment gets
late or default.
Another type is Ijarah, it’s a contract of sale in which the right is given to the partner to use the asset for
time being. It can be known as lease contact, however, before granting the right the asset showed be
owned by the lesser in entire lease period. As asset is owned by the lesser then lesser can ask the asset
back in case of non-payment by the lessee. Also maintenance is done by the lessor unless the damage is
done by the lessee.
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Salam is another type of non-profit/loss sharing financing, in this delivery is done in future in exchange
for spot payment. Such financing was introduced to facilitate small farmers as they wanted initial
investment to grow the crops and the payment is done fully at the time of contract in this kind of
financing, or the end results will turn into debt-against-debt sale, which is strictly prohibited under
Shari’ah. The subject matter, price, quantity, and date and place of delivery should be precisely specified
in the contract.
Another type is istisna, which refers to a contract where goods are transacted before they exist. In istisna’
(or manufacturing) nothing is exchanged on the spot or at the time of contracting, it is the only forward
contract where the obligations of both parties are in the future.
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BACKGROUND:
Islamic finance is also coming to the level of international bank. In its modern form, Islamic banking
started with pioneering experiments in the early 1960s in Egypt. The Mit-Ghamr Islamic Saving
Associations (MGISA) mobilized the savings of Muslim investors, providing them with returns that don’t
exploit the shariah ruling.
The practices of Islamic banking are usually traced back to business people in the Middle East who
started involving in financial transactions with their European counterparts during the medieval era. At
first, they used the same financial principles as the Europeans. However, over time, as trading systems
developed and European countries started introducing new local branches of their banks in the Middle
East, some of these banks acquired the local customs of the region where they were newly introduced,
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primarily no-interest financial systems that worked on a profit-and-loss sharing method. By acquiring
these practices, these European banks could also tackle the needs of local businesspeople that were
Muslim. Beginning in the 1960s, Islamic banking re-emerge in the modern world, and since 1975, many
new interest-free banks have opened. Though the many of these institutions were founded in Muslim
countries, Islamic banks also made their place in Western Europe during the early 1980s. Moreover,
national interest-free banking systems have been developed by the governments of Iran, Sudan, and
Pakistan. All Constitutions of Pakistan have indulged, within the principles of policy, the elimination of
Riba as an important aim of the State policy. Quaid-e-Azam, the father of the nation, in his speech at the
occasion of the inauguration of State Bank of Pakistan, had expressed the wish for evolving an Islamic
system of banking. Article 38(f) of the Constitution of the Islamic Republic of Pakistan provides: “The
State shall …. Eliminate riba as early as possible.” The Objectives Resolution, now a part of the
Constitution, as well as principles of policy stated in the Constitution also introduced an order in Pakistan
where Muslims can live in the individual and collective spheres according to the teachings and
requirements of Islam as set out in the Holy Quran and Sunnah”. In Pakistan Islamic banking emerged to
tackle both religious and economic needs. The earliest efforts for finding substitute to the interest-based
system could be found in a number of reports submitted by the Council of Islamic Ideology (CII).
The role of banks in society has expanded significantly over the years as society has come to expect
people who work in the banking system to take on many of the functions that were originally introduced
or should have been exercised by the state and should become socially and physically aware of economic
and social needs. It can be seen by the previous reports that banks are involving themselves in such
activities that can benefit the economy as whole and following the basic principles of responsible
banking, because of this reason banks have been growing as they are involving in social needs of their
clients.
PRINCIPLES OF RESPONSIBLE BANKING
The banking industry Rules and responsibilities are outline in the principles for responsible banking
which align the banking industry with 2015 Paris climate agreement and un sustainable development
goals. Principles for responsible banking also make it possible for a bank to integrate sustainability in all
of its business operations and to determine where it stands to contribute and have biggest influence on
sustainability and also to incorporate responsibility across all of those areas. These principles also put a
bank in a position to take an advantage of emerging sustainable economic development economic
prospects. Framework for responsible banking is designed to ensure that the strategy and practices of
signatory banks are aligned with societies vision with the guidance of PRB (principals of responsible
banking), the banking industry is better equipped to show to show how its benefits society by providing a
foundation for a long term banking system and how the industry positively contribute to society. The
signatories integrated sustainability into all sectors and at the corporate strategy portfolios and
transactional stages. Islamic finance practices are based on the sharia ruling and according to
interpretations of Islamic ethics risk sharing is more preferable than transferring the risk. The most
notable principle in common is the prohibition of riba which forbid step transactions and risky loans
contrast between the prohibition of riba and zakat in the Quran shows that the formers are completely
contradictory to each other in moral Standing and societal repercussion.
Islamic norms and principles of Responsible banking are similar to various modern accountability and
responsibility measures
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PRINCIPLE #1 ALIGNMENT
The first principle of responsible banking says that the signatory banks should aligned their strategic
plans to be sustainable and contribute to general societal goals and individual needs. Banks should
actively work to enhance funding for environment friendly and socially conscious Industries while
reducing investments in industries that are not aligned. Such as those who do not practice sustainable
forest. Sustainable finance is much more exactly the allocation of funds and investment in sustainable
projects.
Taking an example of Meezan Bank, it is a leading Islamic Bank of Pakistan. The bank has funded Indus
Hospital and health network with 35 million rupees for the development of a solar power system. This
initiative is the component of their sustainable initiative 2022. With the installation of solar panel, the
hospital will be able to lower its escalating electricity costs and direct that money to words the Welfare of
the patients. It encourages a culture of accountability and responsibility through its principles, standards,
practices and personnel.
PRINCIPLE 2: IMPACT AND TARGET SETTING:
According to the second principle banks must analyze their effects on society, economy and environment.
Bank's evaluation and impact analysis should base on:
scope: that includes main business services, areas and products all across the Geographic
locations it continues to operate in.
Exposure scale: where in terms of technologies, geographies and industries the bank's core
activities are located.
Relevance and context: the most important and crucial issues pertaining to sustainable
development in Nations and regions where it operates.
size and intensity of banks’ exposure
Taking an Example of Meezan bank:
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Meezan bank established a specialized department due to the recognition of increasingly diverse
requirement that focuses on investment banking. This department is equipped to offer its client innovative
and comprehensive financial services through a variety of product offerings. By offering sharia compliant
services, bank has built up a solid foundation of experience in project financing as well as offering
guidance.
PRINCIPLE: 3 CLIENTS AND CUSTOMERS
Banks are the most essential economic intermediaries, they contribute most significantly to society goals
by strengthening alliances and ties with clients. They Foster sustainable economic activities and
encourage inclusive growth for future too. Responsible conduct of business practices entails treatment of
customers fairly by comprehending their needs and providing products that meet their needs, being
transparent about pricing and establishing channels for settlement of disputes and customer claims.
Example of Meezan bank:
Meezan Bank created a Framework relating to financial protection of customer that include guiding
principle for business planning, Customer services, sales, financial awareness and complaint handling.
This was done so that customers could make well informed decisions, know their rights and use their
rights to and take advantage.
Policies and procedures at Meezan Bank encourage responsible behavior, sustainable practices and
economic activities. It inspires customers to adopt stringent sustainability standards. It provides
specialized financial goods and services to nonprofit organization who contribute favorably sustainable
economic development through supplier development initiative and innovation hubs. Developing
knowledge inside Bank to advise customers on implementing more environment friendly Business
models, lifestyles and Technology.
PRINCIPLE 4: STAKEHOLDERS
Significant social objectives can be assisted by the banks which contribute greatly to economics system.
Banks can substantially increase the influences of its activities and endorse actions at the level of change
that is required by collaborating with the relevant stakeholders including peer venture capitalist, customer
base, regulatory Agencies, employee’s governance, trade unions and others. Stake holders should be
consulted early on to ensure that your bank gets the most out of their expertise and subject matter
knowledge and that the goals of society can be accurately and legally defined. It enhances credibility and
the capacity to recognize both negative and positive effects. Banks will avoid difficulties down the road if
it actively involves and engages with stakeholders to assure that all essential interest are considered
properly and that future problems won't arise.
Engaging with the stakeholders is important in order to manage reputational risk and confidence not only
builds credibility but also give the understanding of materiality in the field of responsible banking. Banks
can issue better products, operate more ethically and get more devoted by comprehending what is
significant to stakeholders.
Example of HBL:
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Continuous interaction with the diverse stake holders help in better understanding of Banks and sector
related growing threats. To find and constraint the gaps between industry and Academia. HBL and NUST
partnered strategically, the collaboration is still in accordance with the objective of banks to fortifying
ties.
PRINCIPLE 5: GOVERNANCE AND CULTURE
Banks must create governance Framework that facilitate and encourage the effective application of
principles framework documents for responsible banking. In order to manage its enormous consequences
and risk and accomplish its goals, it need to have the right structures, policies and procedures in place.
Additionally, bank will be required to disclose the actions it is taking to cultivate the practices and culture
of responsible banking among its workers.
Taking the example of Askari Bank Limited:
Askari bank works on relationship based plan of actions for long term that provide a specific point only
within the bank for addressing all business necessities of its institutional and corporate clients with the
essential target of a creating client’s services.
PRINCIPLE 6: TRANSPARENCY & ACCOUNTABILITY
Banks are answerable to their staff, society and stakeholders as a whole. Disclosure of information is
important because it enable stake holders to evaluate bank's social impact and its development. Bank's
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commitments to sustainability and responsible banking are strengthened and as a result it set itself apart
from its competitors. The goals are achieved more successfully when targets are made public and
progress is reported. Progress reports and evaluation are essential for guaranteeing the success of strategy,
frosting innovations completing with other and enhances the reputation of the bank. In accordance with
the Principles of responsible banking, banks must disclose information on how they have implemented
the principles in the current public reports.
For example: banks are required to educate the public about their own policies and also about the
activities of finance they provide their clients. Hence they need to be accountable for social consequences
of those actions.
CHAPTER 02
LITERATURE REVIEW:
Many scholars have different thoughts about the Islamic financing as they think it is same as
conventional banking, they just represent it differently, and they also believe that Islamic financing is not
truly based on shariah ruling and they claim that Islamic financing has a debt-like character just like
conventional banking as they think there’s no difference in mark-up and interest. (Aggarwal and Yousef,
1999; El-Gamal, 2006; Hamoudi, 2007), Whereas, many scholars have also claimed that Islamic finance
is the way to fight the macro-financial shock and can encourage or promote economic growth. (Dridi and
Hasan, 2010; Mills and Presley, 1999).
Some articles also state that with the passing time the demand for interest free product is increasing,
therefore, pushing the Islamic financing upwards in the economy, as more and more customers/clients are
interested in Islamic financing and many conventional banks are also introducing some Islamic financing
ways other than the conventional ones. Not only Muslims are interested but Non-Muslims are also taking
the active part in Islamic financing. A report was generated by the State Bank of Pakistan which showed
that more than 300 Islamic financial institutions are operating in almost 75 countries. (Anwar, 2010).
Since 1971, rapid growth in Islamic financing can be seen and through the research it was known that by
the rate of 15% Islamic financing grows and 65 billion in assets. (Wilson, 1995).
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In Egypt the first Islamic bank was established in 1963, whereas, in Pakistan, the first Islamic bank was
established in 1970s, and was re-launched. (Ariff, 1988), and now so many full-fledged Islamic banks in
Pakistan are operating such as Faysal bank, Meezan bank, and Bank Islami, Dubai Islamic Bank, etc.
The news poll held in the year 2008 in which state bank was voted as at second number from the central
banks all over the world that are taking active participation in promoting Islamic financing. The result of
the interest-based economies can be seen because of the current financial crisis. Because of these crises
many successful markets which were on leading were affected so bad that interest rate was brought down
to such extreme that they started taking interest in Islamic financing as it is on the basis of interest free
systems. However, the report also stated that because of these crisis’s Islamic banks were not affected.
To compare profitability, efficiency, and liquidity of two types of banks that are conventional and Islamic
banks, study which was done during the year 2013-2017, took Meezan bank Pakistan and Bank Islami
and they both were compared to two large banks of Pakistan that Standard Chartered bank.
Meezan bank is the first ever Islamic bank in Pakistan and now it is said to be at the top of Islamic banks.
It is also one of the fastest growing bank as its asset average growth is 55% a year and at the end of 2009
total deposits were more than Rs.10 billion, profits earned on the financings were more than 10 billion,
imports and exports businesses which were handled by the bank was more than 100 during the year 2002-
2009. It is also seen that the bank is also well equipped with the latest technology, up to date software and
database system. The bank has a rapidly growing network of branches which is in 204 in number at
present. The bank has acquired cautious approach to fight against the global recession. Meezan Bank has
the vision of introducing Islamic banking as the banking of the first choice’ (MBL, 2009). The bank has a
very prudent and cost-efficient management and the bank has a consistent profitability (Shah, Baloch,
Tahir, & Ali, 2017). The bank also involves in the charity fund mobilization under the Islamic concept of
Qard-e-Hasna which is according to shariah ruling, a loan without any interest or mark-up. Many public
awareness seminars are also conducted by the bank about the Islamic banking (M.B.L., 2012).
Bank Islami is one of the leading Banks in Pakistan with over 320 Branches Nationwide. It is said to be
the Second Largest Islamic Bank. In 2016, Bank Islami Signed an agreement with Akhuwat Foundation,
an Interest Free Micro-finance NGO (Islami, 2018).
Standard Chartered Bank Pakistan works under conventional banking system which was selected for the
comparison. It is an international bank that opened its first branch in 1863 in Karachi. The bank won
many awards such as the Best Foreign Bank in Pakistan, Best Foreign Exchange Provider and the Best
Debt House in Pakistan. The growth rate of the deposits of the bank is 18%, whereas, the gross interest
income increased by 14% in the year 2009. Loans and Advances increased to Rs. 101 billion. The bank
has opted for certain committees to look after certain risks like liquidity, regulatory and credit risk, etc.
(Ahmad, 2016).
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CHAPTER 3
FINDINGS
It can be seen that with these comparisons done by researchers tells that Islamic banks are also growing
and increasing its profitability and making its own place into the market with time and awareness about
their way of financing is spreading and misconceptions of different people are also being correct.
In recent years, many researchers have noticed the significant growth in Islamic financing in form of their
assets and deposits as shown below through the bar graphs, these shows the rapid growth of assets and
deposits since 2016.
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It is also predicted it will keep on increasing as shown in previous years, furthermore chart below shows
the yearly percentage growth of Islamic financing in Pakistan, it is shown that as an evidence with each
year the yearly percentage growth rate has increased.
Banks have also started focusing on environmental factors and have become socially and physically
aware so that they can serve their customers/clients more efficiently. (Relano, Paulet, 2016).
Islamic bank has grab the attention of many scholars in recent years, they have stated that many banks
have ignored the economic principles to just fulfill their greediness Plato nova et al asserted that the banks
who have followed CSR (corporate social responsibility) which was carried by the Gulf Corporation
council (GCR) region have a huge role in improving their financial performances.
Bagh ET AI, examined the 30 banks and was able to come to the conclusion that ROE (return on equity),
ROA (return on assets, and earning per share (EPS) has the positive relation with those banks who play
the role as responsible banks. They also stated that for growth and improving performance of Pakistani
banks, banks should follow the principles of responsible banking.
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Sustainable finance is much more exactly the allocation of funds and investment in sustainable projects.
PRINCIPE: 02 IMPLEMENTED BY HBL
Taking example of a bank: Habib Bank Limited.
Customers of HBL whose banking requirement are expanding beyond traditional channels continue to
receive innovative products and solutions.
Risk analysis by HBL 2022: Habib bank limited has a risk score of 6.00 which is an important major for
evaluating stocks attractiveness. In comparison to its peer group, Habib Bank Limited seems to have a
much higher risk score compared to its peer group it is less risky.
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Promoting responsible and environment friendly practices assisting customers and clients in moving
towards more sustainable business practices and Technology
CHAPTER 04
CONCLUSION
A financial strategy that adheres to Islamic morality is known as Islamic finance. It talks about saving
money, investing, and borrowing money to buy a house.
Islamic finance industry will be continued to grow by 10 to 12 percent over the next two years, despite
the fact that certain countries' GDP growth is expected to be lower. Through fair financial dealings and
redistribution of wealth, Islamic finance aims to improve social justice. Principles for Responsible
Banking's goals and those of Islamic finance's stakeholders are very similar. The Principles give Islamic
banks a chance to be seen responsible for how they run their businesses and deal with both the good and
bad effects of their activities.
There is a clear and acknowledged connection between the fully integrated values of Islamic finance and
those attempting to persuade banks to join the Principles for Responsible Banking, but not as much as
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could be. This is in part because the Principles for Responsible Banking view responsible finance as an
evolving process based on a bank's capabilities and its stakeholders' expectations.
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