The Difference between Islamic and Conventional Banks Finance Essay

Islamic banking refers to a system of bankor banking activity that is steady with the ideology of Islamic rule (Sharia) and its realistic application through the growth of Islamic finances.

OR

Financial services that meet the necessities of the Shariah, or Islamic rule. While considered to meet the exact religious necessities of Muslim clients, Islamic banking is not limited to Muslims: both the fiscal services provider and the customer can be non-Muslim as well as Muslim.

Difference between Islamic and conventional banks :

There are a number of key difference between the goods and services existing by a conventional bank in relationship to an Islamic financial organization.

Islam is the back bone of interest free banking, moral values and objectives play a more important role in its operation. As such it is prepared on the basis of collaboration with each other as stated in the Quranic induction: "Help you one another in righteousness and piety but help you not one another in sin and trasgression" (Quran, 5:2). The Quran also calls for deal "Eat not up your property among yourselves in vanities but let there be amongst you, traffic by mutual goodwill"(Quran, 4:29). Honesty and trustworthiness is so essential in big business, thus the Prophet (Pbuh) had stated that dishonest dealings are against the law (reported by Bukhari).

Secondly, no gain is accepted without either attempt or liability. Islam forbids getting a economic advantage without giving a offset value, but is not conflicting to profit or financial gain as long as an effort is perform or (partial) legal responsibility is accepted for the economic result of a scheme.

Thirdly, general circumstances of a nonpayer should be evaluated authentically. If one is in financial misery, and is not able to pay back the primary, one should be given an extension on humanitarian ground without any penalty. (Quran, 2:280)

Fourthly, certain business contact are measured unlawful in Islam and cannot be carried out in an Islamic bank. For example trade in alcohol, intoxicating drugs, gambling or producing pornography are dissimilar to Islam.

5 . Fifthly, Islamic banks offer no interest-bearing products or services, and in its organisational arrangement and corporate power, Islamic banks have Shariah board, to ensure that the bank practice are in agreement with the Shariah and do not oppress the deprived client.

ISLAMIC BANKING IN PAKISTAN :

Islamic Banking Department was establish on 15th September, 2003 and has been entrust with the task of promote & developing the Shariah obedient Islamic Banking as a similar and friendly banking system in the country.

Islamic Banking is one of the rising field in global monetary market, having marvelous potential and growing at a very fast pace all around the world. Al-Hamdulillah, the progress of Islamic Banking in Pakistan has also been admirable during the last Five years. Currently there are five licensed full fledged Islamic Banks and twelve conventional banks with separate Islamic Banking Branches with the total branch network of over 336 branches operating in more than 50 cities of all the four provinces and Azad Kashmir in the country as of 17.07.2008 and applications for few more players are under thought. Islamic Banking is a high main concern area for State Bank of Pakistan. Steps are being taken to make Islamic banking business in Pakistan robust enough to offer a viable alternative to predictable banking, should the market make a decision that Pakistan should have an entirely Islamic banking system in the country.

State Bank of Pakistan wants to develop a progressive and sound Islamic banking system that is in line and compatible with the global economic sector, providing new Shariah compliant products and services so as to achieve fair economic increase.

CHAPTER 2

BAI'SALAM :

Bai Salam is a form of onward contract when the price for an asset is fully paid in advance at the time of the agreement for an asset or goods to be delivered at some upcoming dates.

OR

in Islamic financing, a contract for the buy of goods to be deliver at a particular time in the future. Payment for the commodities is made in advance

HISTORY OF BAI'SALAM :

When riba is declared haram by Allah, farmers of Madinah could not take riba base credit.

At that time Holy Prophet (PBUH) allowed them to sell their manufacture in advance and to take full payment at the time of agreement which is clearly define in Hadith "Whoever pays money in advance (for fruits) (to be delivered later) should pay it for a known quality, specified calculate and weight (of dates or fruit) of course along with the cost and time of release "

ITRODUCTION TO BAI'SALAM :

Advance expense for goods which are to be deliver at a specified upcoming date. Under usual circumstances, a sale cannot be effect unless the goods are in continuation at the time of the bargain. However, this type of sale is an exclusion, provided the goods are defined and the date of delivery is fixed. The objects of sale must be physical goods that can be define as to the quantity, quality and workmanship.

Three basic conditions of sale

Firstly, the asset must be real.

Secondly, the seller should have acquire the possession of that asset. Therefore, if the asset exists, but the seller does not possess it, he has no right to sell it.

3.Thirdly, only the ownership is not enough. The seller must of the possession, either physically or constructively. The only exception to this rule is the contract of Bai Salam (Trust Sale) and BaiIstisna (Order Sale). These two contracts deal with the sale transaction involving an asset which is at the point of contract, is non-existence.

CHAPTER 3:

CONDITIONS OF BAI'SALAM:

Price of manufactured goods would be paid in cash, instant and full at the time of contract. In the absence of full payment it will be same as to sale of debt against a debt, which is expressly forbidden by Holy Prophet (PBUH). The basic reason of Salam is to fulfill the immediate need of seller.

The object of the trade must be tangible i.e. can be particular according to weight, size, volume, color, quantity, quality or grade.For example, valuable stones cannot be sold on the basis of Salam, because every piece of costly stones is normally unlike from the other either in its class or in its size or weight and their precise requirement is not usually possible.

The place, cost and time of the release must be specific. Delivery in installments is allowed, if agreed by all parties.

The item should be existing in the bazaar till the time of agreement to delivery or at least till the date of release. Because, in case of any accident seller make sure the delivery by purchase that item from bazaar.

The seller at the time of release delivers product and not cash to the buyer.

Cancellation of the Salam Sale :

This means to end the contract by returning the price to the purchaser and the commodity to the vendor when the buyer receive the price. It is generally permissible if the arrival is full otherwise it would not be allowable. A partial return is suitable according to Abu Haneefa and shafiand a unacceptable according to Ahmed as reported by IbnRushd reported, it should not less or more than the thing meant or else it be unacceptable.

In case of Death:

The greater part of fuqaha think that late debts, honoured by trust, can be present when the debtor dies. One of these is the salam (salamfeehi).

Al Kasany said: .If the seller dies before the particular date of delivery the debt must be incumbent upon this legacy and these fore the inheritors have to complete.

Application :

Salam can be used for facilitate farmer clients who need functioning capital/ running finance. The buyer has an benefit of purchase particular goods at a comparatively lower price. On the other hand, the supplier gets early price of those items / commodities which have not been produced yet. This may help him meet the functioning capital supplies.

Agriculture is broadly confidential into crop and non-crop sectors. The two sectors are quite different in terms of finance requirements and cash flows. IBIs are concerned in agriculture financing for both the sector.

Crop Sector:

Financing for raising crops or horticulture by the agricultural community is classified under the crop sector credit. There are two main cropping season: Rabi and Kharif. The period for Kharif crops starts from March to August. The significant Kharif crops are cotton, rice, sugarcane, Maize, Jawar and Bajra. The period from September toFebruary is Rabi season and main crops of the season are wheat, Barley, Gram and Mustard seeds. Banks provide credit ability in crop/farm sector for manufacture i.e. financing for buy of inputs or working capital which is Salam based and, growth purposes i.e. financing for the purchase of equipments or other long term savings at the farm.

Non Crop Sector:

Financing for non-crop farming actions like livestock, fisheries, poultry, sericulture, apiculture etc. is confidential under non-crop sector credit. Banks provide finance to farmers to meet finance needs of manufacture as well as growth under this group.

PROCEDURE AND MECHANISM :

Whenever a farmer require financing for farming or growth of crops, he will go to the bank and ask for some finance services. Instead of providing credit, as predictable banks, the Islamic bank will make a future sale contract with the client which is known as Salam contract. That agreement covers following salient aspects:

The agreement describe complete qualifications of the goods, sale price and date and place of delivery Collateral or mortgage is determined.

Conditions of default and extinction are describe and by this Initial Salam contract is signed in the presence of witness(two by bank and two by farmer).

1 Eligibility of Customer :

Customer should be a holder of computerized NIC while usual necessities for corporate clients would apply.

Customer should not be a debtor of any IBI / financial institution.

IBI is satisfied and feels comfortable with the farmer and guarantor (where applicable) identity character, status and credit worthiness.

2 Pricing Strategy:

In Salam contract, there is no standardized limit for determining the price of the product so the price is determined on the basis of conciliation between Bank (buyer) and cultivator (Seller). The price is by keeping following aspect Price of goods is taken by daily Index price (Newspapers).

The price of the product, delivered in future date is determined. This is constantly less 

than the Index cost.

Example:

Working Capital Required (Farmer):Rs. 10,000

Price ofWheat (Index Price):Rs. 500/ per bag (1 bag = 40 kg)

Negotiable Price ofWheat:Rs.350/ per bag*

According to this conciliation farmer will be liable to carry 29 bags when the crop is

harvested on the particular future time.

3 Written Offer:

after deciding all the matters stated in above early Salam contract, the cultivator gives a written offer for the trade of goods at the negotiate prices to ensure the deliverance it also include 

Description of the Goods

Validity of the Offer

Delivery Date

Terms of delivery

Place of delivery

IBI is satisfied and feels at ease with the farmer and guarantor (where

applicable) identity quality, reputation and creditworthiness.

4 Delivery Notice:

when crops are harvested then farmer issues a deliverance notice in the name of organization. After getting delivery notice bank send field executive for the inspection of the manufactured goods. Delivery notice include

Delivery Date

Place of delivery

Description of the Goods

Additional remarks (if any)

5 Goods Receiving:

Notice: after getting the product, bank sends in receipt of notice to the cultivator or supplier for ensuring the deliverance of the specified manufactured goods.

6 Sale to ThirdParty :

When goods have been delivered by the vendor (farmer) then bank have to put up for sale the products to the third party this sale is passed by two ways

Parallel Salam:

After the implementation of Salam agreement with one party, buyer or seller execute another Salam contract with third party,

Conditions for Parallel Salam:

There must be two dissimilar and autonomous contracts, these two contract cannot be tied up and presentation of one should not be dependent on the other.

Parallel Salam is acceptable with third party only.

Agency Agreement:

After the deliverance Bank signs a new contract with the contractor (farmer) and hire him as agent for the sale of manufactured goods to third party.At this stage Bank has a contractual ownership of product. Agent sells product on the behalf of Bank. Agent specify his motivation in sale for his hard work with approval of Bank.

Risks Involved in Salam :

Under this opinion, the bank always acts as a buyer and it pays the decided price to the farmer (seller) upon signing of agreement. The goods are then deliver to the bank on the predefined upcoming date and after this bank act as a vendor. The risks concerned in the mentioned contract are as below:

Market Risk:

Since the deliverance of goods/crops is on upcoming basis, so at the time of delivery price of goods can be less than the price of buy.

Delivery Risk:

The goods/crops are not deliver to the bank on pre-agreed date or are not according to the agreed requirement.

Credit Risk:

if the provider (Farmer) is not capable to deliver the manufactured goods then bank can mitigate the credit risk by keep the property of provider as collateral.

Risk of Damage:

after delivery, manufactured goods is in banks possession either physical or contractive. If any harm occurs without the carelessness of agent, bank has to swallow the risk. To diminish risk bank will insure the product by contract with Takaful Agency.

Scope and Potential of Salam :

The Salam sale has the elasticity to cover the wants of various sector of people such as farmers, industrialists, contractors, exporters or traders. It can be used to meet the capital necessities as well as to meet the cost of operation.

Salam sale is proper to finance the agricultural operation where the bank can transact with farmers who are expected to have the goods in penalty throughout harvest either from their own crops or crops of others, which they can buy and bring in case their crops fail. Thus the bank renders great services to the farmers in their way to achieve their manufacture targets.

Salam sale is also used to finance the commercial and industrial behavior, especially in phases prior to manufacture and export of commodities and that is purchasing it on Salam and marketing them for lucrative prices.

The bank in financing craftsman and small producers applies the Salam sale by supplying them with the inputs of manufacture as a Salam capital in substitute of some for their property to market

CHAPTER 4 :

Salam inPakistan :

established Islamic Banks are not providing any Salam base product however almost all

Islamic Banking Branches (IBBs) are providing Salam base product in farming such as

Islamic Divisions of

Soneri Bank ltd

Askari Bank ltd

Bank Alfalah ltd

UBL Ameen ltd

SONERI BANK LTD 

Agriculture Financing

Following agriculture finance facilities are provided by Soneri Bank Limited at its selected branches.

Production Loans

Production loans are offered to meet the input and other working capital requirements for farming, orchards and nursery, tunnel farming, storage of raw material, transportation marketing grading and packing etc., by farmers.

Note: Financing facilities for all other purposes as detailed in SBP list of eligible items for Agricultural Credit are also available.

Development Loans

Development loans are offered for the purchase of tractors, trolley, thrashers, ploughs, cultivators, laser levellers, combine harvesters, processing machinery, transport for delivery of dairy, poultry, fisheries. Installation of tube-wells, turbine, land levelling, soil improvement, land reclamation, seed processing units and for godowns, silos and cold storages.

Livestock

To meet the fixed cost and working capital requirements for cattle farming, cattle feed units, dairy farming, poultry farming; poultry feed units and fish farming.

Repayment Period

Principal amount of Finance plus mark-up thereon is repayable depending upon nature of business ranging from one to five years. Revolving facility is also available under specific terms.

Mark-up Rate

All Type of Agriculture Loans upto Rs. 100,000/-

6M Kibor + 2%

Production Loan under Revolving Credit Scheme

6M Kibor + 3%

Working Capital for Live Stock i.e.(Dairy, Fisheries and Poultry etc)

6M Kibor +3.5%

Development Loan (All kinds)

6M Kibor + 4%

ASKARI BANK LTD :

Products:

Kissan Evergreen Finance

Kissan Tractor Finance

Kissan Livestock Development Finance

Kissan Farm Mechanization Finance

Kissan Aabpashi Finance

BANK ALFALAH LTD :

Bank Alfalah Limited acknowledging the vital role of a agriculture in the economic development of Pakistan has designed Rural Finance Program named as "BANK ALFALAH ZARIE SAHULAT". The product is designed to cater for multiple financing requirements of our farming sector.

We are caring our customers through chain of complete, distinguished and specialized products for agriculture sector. BAL Branches are designed to help the farmers with expert advice, technical know-how and Credit for their multifarious activities through timely, affordable and attainable modes tosuit farmer requirements.

BANK ALFALAH ZARIE SAHULAT is available for Short, Medium and Long terms.

Bank Alfalah Limited Strategy is to focus on following Objectives:

Provide reliable infrastructure for Agri customers.

Help farmers utilize funds efficiently and effectively.

Provide farmers an integrated package of credit, supervision and technical know-how.

Bank Alfalah Limited is committed to make dreams come true by making Pakistan's Rural Economy healthier and stronger.

Conditions of Agriculture Finance in Pakistan :

cultivation constitutes the largest sector of our economy. Majority of the population, directly or indirectly, needy on this sector. It contribute about 24 percent of Gross Domestic Product (GDP) and financial records for half of employed labor force. There is a great scope in the cultivation financing for Islamic Banks.

In Pakistan, there are more than 700 Islamic Bank branches but if we take a look at products and services offered by Islamic Banks, Salam is only 1% of total operations in 2009. But if we look at the figures of last years, we came to know that, instead of addition in this percentage there is a decline from 2%(2007-08) to 1%(2009).According to Islamic banks moral hazards is the main cause of not financing in this sector. But according to our view banks should not rely on assumptions only but need to invest the short part of their asset and then decide whether to spend or not.

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