Operational Aspects & Practices of Islamic Banking System

1. Chapter 5
Operational Aspects
&
Practices Of
Islamic Banking System
Made by:
Nor Izzuddin Bin Norrahman, BBA.
Lecturer of Management,
Banking & Islamic Finance
Astin College, Puchong

2. Contents…
• Services Provided By Islamic Banks
– Deposit Facilities
– Financing Facilities
– Other Facilities
• Source Of Funds
• Social and Welfare Activities
• Accounting Policies
• Risk Management

3. Services Provided By IB
• Islamic Banks is an institution which involved
bank activities.
• Thus, Islamic Banks should provide services
which can meet the needs of a range of users.

4. • ‘Users’ can be categorized as:
– Individuals
• Individual with excess money who want to make a deposit
for precautionary or investment purpose.
• Individuals who requires financing for investment or
personal needs.
– Business Organizations
• For businessmen hold money for transactions and
investment purposes.
• Businessmen who require financing to either start or expend
their business.
– Government Bodies
• For investment purposes.
• To finance its budget deficit.

5. • Islamic Banks also offer other facilities in order to meet
the needs of their customer.
• Such services include:
– Letters of credit (LOC)
– Letters of guarantee
– Money Order
– Foreign Exchange
– Cheque
– Bank Draft
– Advisory services
– Etc.
• Hence, services offered by Islamic banks may be
classified into three groups:
– Deposit Facilities
– Financing Facilities
– Other Facilities

6. Deposit Facilities
• The following are some of the similarities and
differences among the deposit facilities
provided by Islamic Banks:
– The Similarities
– The Differences

7. • The Similarities
– Islamic banks all over the world (except for Turkey)
provide three types of deposit facilities which is:
• Current Account
• Savings Account
• Investment Account
– In general, the investment account facility can be
divided into three categories which is (1) based on
time, (2) based on notice [Only in B’desh, Jordan
& Bahrain], and (3) based on specified projects /
purposes.
– Most banks provide a guarantee to return the full
amount of deposits placed by customers except in
profit sharing facility.

8. • The Differences
– There are some differences in the treatment of the
savings account facility among Islamic Banks.
• Iran, Pakistan and UAE regard the savings account as a
facility itself.
• B’desh, Kuwait, Jordan consider it as one of the facilities in
the investment account.
• M’sia & Indonesia offer two types of savings account, that is,
accounts using the wadiah and mudahrabah principles
– Sometimes there are differences in terms of the
Syariah principles used in the deposit facilities in
Islamic Banks.
– There are Islamic Banks which offered rewards/return
to the depositors for their deposits (Malaysia & Iran).

9. Deposit Facilities Provided by Islamic Banks
Iran M’sia Pakistan B’desh Kuwait
Current Acc.
Savings Acc.
Investment
Acc.
Mudharabah
Funds:
-Current acc.
-Savings Acc.
Negotiable
Islamic Debt
Certificate
Others
Non-mudharabah
fund:
-Savings Acc.
Investment Acc.
Current Acc.
Savings Acc.
Fixed Deposit
Term Acc.
Other Deposit
Current acc.:
-Taka acc.
-Dollar acc.
-Foreign Currency
acc.
-Property
development acc.
Mudharabah
Deposit:
-Savings
-Special Notice
-Fund Bonds
Term Mud.
Non-Investment
Deposit:
-Current Acc.
Investment
Deposit:
-Restricted
-Non-Restricted
Savings Acc.

10. Deposit Facilities Provided by Islamic Banks (2)
Jordan Bahrain Turkey UAE Indonesia
Trust Acc.:
-Current Acc.
-Demand Acc.
Non-Restricted
Investment
Acc.:
-Savings
-Notice
-Fixed
Restricted
Investment Acc.
Muqaradah
bond
Current acc.
Non-Restricted
Investment Acc.
Non-Restricted
Investment Acc.
Special Current Acc.
Participatory Acc.
Current acc.:
Savings Acc.
Investment Acc.
Wadiah Acc.:
-Demand
-Savings
Non-Restricted
Mudharabah Acc.:
-Savings
-Term

11. Savings Account - Wadiah
Source: https://www.sc.com/my/islamic-banking/sme-banking/biz-current-account-i/en/index.html

12. Savings Account - Mudharabah

13. Financing Facilities
• Islamic banks also offer financing facilities to their
customers.
• Financing for businesses:
– Short Term
• For meeting working capital
– Long Term
• Covers capital expenditure
• Financing for individuals:
– Financial aid
• Housing
• Personal
• Goods

14. • Since the only recognize loan in Islam is qard hassan,
all financing operations are either based on the profit-
loss sharing principle or the principle of fees,
commission and fixed charges.
• The is no clear rules in terms of priority in the use of
principles when meeting the financing needs of
customers.
• However, the principles of mudharabah and
musyarakah are widely used in financing working
capital (short term).
• While the principles of murabahah, bai muazzal and
ijarahare used to finance fixed assets for the
customers.
• The financing principles used by the Islamic Banks
depend a lot on the law governing their operations.

15. Table 6-4: Percentage of financing based on syariah principles
Source: Sudin Haron, W. Nursofiza, (2009). Islamic Finance and
Banking System : Philosophies, Principles & Practices. PG.
305, Selangor, Malaysia. McGraw-Hill (Malaysia) Sdn. Bhd.

16. Principles
BIMB,
Malaysia
SBOB,
Bahrain
IBB,
Bangladesh
BMI,
Indonesia
KFH,
Kuwait
Albaraka
Turk,
Turkey
DIB, UAE
IIAB,
Jordan
Musyarakah - 8.8 0.7 43.2 - - 7.8 0.1
Mudharabah 0.09 9.7 <0.05 56.8 - - 11.3 3.8
Murabahah 17.7 75.0 50.9 - 91.0 - 45.1 68.1
BBA 52.8 - - - - - - -
Ijarah 2.6 4.9 - - - - 18.5 19.3
Qard Hassan - - 1.3 - - - - 0.2
Istisna 4.9 - - - 8.9 - 13.5 -
Other
Principles
21.9 1.6 47.7 - - - 3.8 8.5
Total 100 100 100 100 100 - 100 100

17. Other Facilities
• Apart from deposit and financing, Islamic banks also
provide other facilities to their customer.
• Such facilities depend on the capability and capacity of the
particular bank.
• The facilities are:
– Letters of credit (LOC)
– Letters of guarantee
– Money Order
– Foreign Exchange
– Cheque
– Bank Draft
– Advisory services
– Etc.

18. Steps in Letter of Credit
• Source:
http://www.aibtradefinance.com/tf/productdi
ag.asp?5

23. Types of LOC in IB
• Wakalah
• Musyarakah
• Murabahah

24. Source Of Funds
• Generally, there are three main sources of
funds for Islamic banks which is:
– Deposit
– Other Liabilities
• Funds acquired from other liabilities, usually from short
term liabilities.
– Shareholders’ Funds
• Paid-up capital, various reserves and retained earnings.

25. Source Of Funds
BIMB,
Malaysia
SBOB,
Bahrain
IBB,
Bangladesh
BMI,
Indonesia
KFH,
Kuwait
Albaraka
Turk,
Turkey
DIB, UAE
IIAB,
Jordan
Deposit 88.4 72.3 86.9 87.0 74.4 81.2 77.6 84.8
Shareholders
’ Funds
5.6 20.5 6.2 8.0 16.0 14.5 12.7 12.5
Others 6.0 7.2 6.9 5.0 9.6 4.3 9.7 3.1
Total 100 100 100 100 100 100 100 100
Table 6-7: Sources of Funds of Islamic Banks (%)
Source: Sudin Haron, W. Nursofiza, (2009). Islamic Finance and
Banking System : Philosophies, Principles & Practices. PG. 316,
Selangor, Malaysia. McGraw-Hill (Malaysia) Sdn. Bhd.

26. Uses Of Funds
• Islamic banks use their funds according to the
types of assets held.
• Mainly, there are five main categories:

27. – Cash
• Includes cash in hand, balance with the central bank or
reserves and balances with other financial institutions.
• Usually, banks do not hold high percentages of cash.
• The amount of reserves kept with the central bank
depends on the ratio set by the central bank.
• It is also depends to a large extent on how the central
bank implements its financial policies.
– Financing
• Comprises all loans extended under the principles of
mudharabah, musyarakah, murabahah, bai muazzal,
ijarah and qard hassan.

28. – Investment
• Includes the investment in government securities,
treasury bills and investment in subsidiaries and
associated companies.
– Fixed Assets
• Include all land, buildings, vehicles, factories, furniture,
and fixtures.
– Other Assets
• All assets that are not categorized under the four
mentioned categories.

29. Source Of Funds
BIMB,
Malaysia
SBOB,
Bahrain
IBB,
Bangladesh
BMI,
Indonesia
KFH,
Kuwait
Albaraka
Turk,
Turkey
DIB, UAE
IIAB,
Jordan
Cash 42.2 28.2 8.9 1.6 6.3 4.0 5.9 5.9
Financing 38.5 39.4 75.7 38.7 57.5 73.0 58.4 51.1
Investment 15.6 26.9 10.6 0.4 6.7 0.1 11.3 4.3
Fixed Asset 0.5 0.6 4.5 0.7 4.6 1.1 0.8 1.5
Other Asset 3.2 4.9 0.3 58.6 24.6 21.8 23.6 37.2
Total 100 100 100 100 100 100 100 100
Table 6-9: Sources of Funds of Islamic Banks (%)
Source: Sudin Haron, W. Nursofiza, (2009). Islamic Finance and Banking
System : Philosophies, Principles & Practices. PG. 319, Selangor, Malaysia.
McGraw-Hill (Malaysia) Sdn. Bhd.

31. Social and Welfare Activities
• Most Islamic banks have a high sense of
corporate social responsibility (CSR).
• The Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) –
responsible for preparing and issuing
accounting standards of Islamic Banks.
• AAOIFI does not provide any standards on
matters relating to social responsibility.

32. • However, AAOIFI provide standards that deal
with the determination of zakat.
• In includes:
– Measurement of items to be included in the zakat
base
– Disclosure of zakat in the financial statement of
Islamic Banks.
• In this case, zakat is regarded as a social rather
than religious responsibility.

33. Accounting Policies
• Islamic banks must comply with Islamic
business principles in all their transactions.
• As such, many Muslim scholars are of the view
that Islamic banks should have methods of
measuring , recording and reporting of
transactions that are differ from the
conventional banks.

34. • It was as a result of the recommendations
made regarding the need to have a common
standard of accounting for Islamic banks that
the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) was
formed in 1991.
• AAOIFI has produced several standards related
to accounting and other financial transactions
of Islamic banks.

35. The Basis of financial statement
preparation
• Islamic banks are not legally bound to comply
with these standards set by AAOIFI.
• This is because Islamic banks somehow have to
comply with standards and legislation imposed by
the regulatory authority of those country.
• Example: Malaysia – Companies Act 1965
• Islamic banks which comply with AAOIFI
standards are mostly originating from Middle
East.
• This is also indicate that the acceptance of
accounting standards by AAOIFI is relatively low.

36. Revenue Recognition
• Revenue recognition is the record of revenue
when an exchange transaction has taken place
or when the earning process has been
completed.
• Not all Islamic banks describe their revenue
recognition policy in their annual reports.
• Nonetheless, the methods of recognizing
revenue may be vary among them.
• AAOIFI has issued a guide on revenue
recognition.

37. Investment
• Investment is one of the methods on how
Islamic banks generate revenue.
• There are four types of investment:
– Purchase of negotiable securities (Shares, bonds,
etc.)
– Investment in subsidiary & associated companies
– Investment in properties and real estates
– Other investment

38. Provision for doubtful debts
• Doubtful debts or bad debts are unavoidable in
the banking industry.
• For this, AAOIFI has suggested that Islamic banks
present four matters related to the doubtful
debts:
– Provision charged to income statement during the
period
– Receivables written off
– Receivables collected which previously written off
– The balance of the allowance for doubtful debts as of
the beginning and end of the period.

39. Fixed asset and depreciation
• Fixed assets are assets bought to generate
revenue.
• Fixed assets are usually in the form of:
– Buildings
– Motor Vehicles
– Office Equipment
– Management information system
• AAOIFI does not provide the detailed
guidelines related to fixed assets.

40. Allocation of profit
• One of special features of Islamic banks is the
application of profit-loss sharing principle in their
transactions.
• Depositors of Islamic banks does not know in
advance returns from their deposit unlike the
conventional banks. This is because IB use
mudharabah principles.
• AAOIFI merely states that Islamic Banks will
receive return in the form of percentage of the
profit.

41. Payment of zakat
• The obligation to pay zakat is another unique
features of Islamic Banks.

42. Risk Management
• Market Risk
• Credit Risk
• Liquidity Risk
• Operation Risk
• Syariah-compliance Risk

43. • Source:
Sudin Haron, W. Nursofiza, (2009). Islamic Finance and
Banking System : Philosophies, Principles &
Practices, Selangor, Malaysia. McGraw-Hill (Malaysia) Sdn.
Bhd.