PRACTICE OF SHARIAH BASED BANKING: A STUDY ON SHAHJALAL ISLAMI BANK LIMITED

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PRACTICE OF SHARIAH BASED BANKING: A STUDY ON SHAHJALAL ISLAMI BANK LIMITED

CHAPTER 1: INTRODUCTION

When British banking giant HSBC Group began offering mortgages carefully formulated to meet Islamic banking practices last year in Malaysia, it was surprised that more than half of its customers were non-Muslim. What drew these customers to alternative financing that conforms to the strict dictates of Islam? Bank officials say that competitive pricing makes their Muslim-friendly mortgages — which operate more like leases than loans — competitive with traditional interest-based financing (Businessweek, August 8, 2005). Whatever the reason is, it is now clear that Islami Banking is no longer a new thing. And no longer is this statement valid that Islam was okay only for the ages of 1400 years ago. From Jakarta to Jeddah, 265 Islamic banks and other financial institutions are now operating in some 40 countries, with total assets that top $262 billion, according to organizers of the International Islamic Finance Forum, a semi-annual industry conference. Most of the large Western financial institutions, following the example of Citibank, have their own Islamic subsidiaries or Islamic “windows” or products aimed at their Islamic clientele. As proof of how many companies are compatible with Islamic law – and not just from within the Muslim world – there is now even a Dow Jones Islamic market index (Ibrahim, 2006). Alongside the conventional interest bearing banking system, Bangladesh entered into an Islamic banking system (profit-loss sharing) in 1983. At present, out of 48 banks in Bangladesh, 6 private commercial banks are operating as full-fledged Islamic banks and 10 conventional banks are partially involved in Islamic banking in a total of 20 branches. Total deposits of the Islamic banks and Islamic banking branches of the conventional banks stood at Taka 232981.00 million at end June 2006. This was 28.46 percent of the deposits of all private commercial banks and 9.67 percent of the deposits of the total banking system at the end of June, 2006. Total investment of the Islamic banks and the Islamic banking branches of the conventional banks stood at Taka 210493.80 million at end June 2006. This was 29.35 percent of all private banks and 14.88 percent of the total banking system of the country (Abdullah, 2007). Fifteen commercial banks of the country, including six full- fledged Islami banks, are the members of Central Shariah Board for Islamic Banks of Bangladesh. Excepting Islami banks, 21 branches of nine conventional banks, including Standard Chartered Bank and Hong Kong and Sanghai Bangking Corporation, are rendering Islamic banking services under the existing Islamic Banking Shariah law. According to a Bangladesh Bank Report, Islamic banking industry continued to show strong growth since its inception in 1983 to June 2007 in tandem with the growth in the economy as reflected by the increased market share of the Islamic banking industry in terms of assets, financing and deposits of the total banking system. According to the report, the total deposits of the Islamic banks and Islamic banking branches of the conventional banks stood at Tk 286.5 billion at the end of June 2007. This was 23.6 per cent of the deposits of all private commercial banks and 14.3 per cent of the deposits of the total banking system. Total investment of the Islamic banks and the Islamic banking branches stood at Tk 265.4 billion at the end of June 2007. This was 26.9 per cent of all private banks and 17.2 per cent of the total banking system of the country. Now Dhaka is being seen as the potential International Islamic Banking Center (Financial Express)^.

1.1 Origin of the report

This report was assigned by my supervisor in the International Islamic University Chittagong as part of the requirement for successful completion of the Internship program. Exposure to the business world and acquiring practical work experience was the primary objective of this assignment. I was attached with Shahjalal Islami Bank Limited (Dhaka Main Branch) for my internship. The report focuses on Investment division as I was attached with that division during the tenure of my internship.

1.2 Objectives

General objective of this report cognates the internship purpose. The internship objective is to gather practical knowledge and experiencing the corporate working environment with the close approximation to the business firm and the experts who are leading and making strategic decisions to enhance the growth of a financial institution. To this regard this report is contemplating the knowledge and experience accumulated from internship program.

Every task has its respective goals or objectives without which the work is meaningless. Keeping the following objectives in my view I have prepared this thesis paper.

To acquire a general idea about the Investment modes of an Islamic Bank

The MAJOR MODES of Islamic banking and finance

To observe the difference between the modes of the conventional banking system and those of the Islamic Ones

• To learn about variation of products & services.
• To gain practical exposures in different banking activities
• To apply theoretical knowledge in the practical field.
• To study existing banker customer relationship.
• To gain practical exposures in different banking activities
• 1.3 Scope of the study

This report covers the organizational structure, background, and basic functions of the various divisions and the performance of Shahjalal Islamic Bank Limited. In case of the project part, the study area and observations are limited to Investment division only. The observations provided in this report are general in nature and are not representative of the total population of SJIBL, neither is it supported by formal, full-scale attitude survey.

1.4 Methodology

The study requires various types of information, procedures, and method of credit management. Both primary and secondary data available have been used in preparing this report.

Sources of Data –

1. Primary Sources

a) Discussion with officials of Shahjalal Islami Bank Limited.

b) Expert opinions comment.

c) Work with them.

2. Secondary sources

a) Relevant books, newspaper, journals etc.

b) Monthly reports.

c) Published documents.

d) Office circular.

e) Other published papers, documents and reports.

f) Internet

g) Annual report

h) Journals

i) Bangladesh Bank publication

1.5 Limitations of the Study

Every project has some limitation. During the course of my practical orientation I faced some usual constraints.

• Unavailability of sufficient written documents as required making a comprehensive study.
• Because of the unwillingness of the busy key persons, necessary data collection became hard.
• Credit department some times is very confidential, so getting adequate relevant information was difficult.
• The report is primarily based on the data collected by interviewing concerned officers.

• In many cases, up to date information is not published.
• Limited time of internship program.

Lack of Data required for the study of the proper practice.

Inaccurate or contradictory information.

Field practice varies with the standard practice that also created problem.

Time provided for conducting the study is another important constraint.

CHAPTER 2: LITERATURE REVIEW

2.1 ISLAMIC BANKING CONCEPT, HISTORY & BASIC FEATURES

2.1.1 WHAT IS ISLAMIC BANKING

Islam banking has been defined in a number of ways. The definition of Islamic bank as approved by the General Secretariat of the OIC is stated in the following manlier. “An Islamic bank is a financial institution whose status, rules and procedures expressly state its, commitment to the principle of Islamic Shariah and to the banning of payment of interest on any of its operations.” The original meaning of the Arabic word shariah was ‘the way to the source of life’ and it is now used to refer to legal system in keeping with the code of behavior called for by the Holly Qur’an (Suleiman, 2008). It has also been opined that it is natural and imperative for an Islamic bank to incorporate in its functions and practices commercial investment and social activities, as an institution designed to the civilized mission of an Islamic economy (Shawki, 2005). It appears from the above definitions that Islamic banking is a. system of financial intermediation that avoids receipt- and payment of interest in its transactions and conducts its operations in a way that it helps achieving the objectives of an Islamic economy. Alternatively, this is a banking system whose operation is based on Islamic principles of transactions of which profit and loss sharing (PLS) is a major feature ensuring justice and equity in an economy (Akkas, 2008). That is why Islamic banks are often known as PLS-banks.

2.1.2 Theoretical Basis of the Concept of Islamic Banking

The Conventional banking is essentially based on debtor-creditor relationship between the depositors and the bank in the one hand, and between the borrowers and the bank on the other. Interest is considered as the price of credit, reflecting the opportunity cost of money. Islam, on the other hand, considers loan to be given or taken, free of charge, to meet any contingency and that the creditor should not take any advantage of the borrower. When money is lent out on the basis of interest, more often it happens that it leads to some kind of injustice (Akkas, 2008).

The first Islamic principle underlying such kinds of transactions is that “Deal not unjustly (by asking more than your capital sums), and you shall not be dealt with unjustly (by receiving less than your capital sums). And if you do not (deal justly), then be informed of a war [against you] from Allah and His Messenger. But if you repent, you may have your principal [thus] you do no wrong, nor are you wronged.” (Quran: 2-279). Hence, commercial banking in an Islamic framework is not based on debtor-creditor relationship.

The second principle regarding the financial transactions in Islam is that there should not be any reward without risk taking and that this principle is applicable to both labor and capital. As no payment is allowed to labour unless it is applied to work, no reward for capital should be allowed unless it is exposed to business risks (Akkas, 2008).

Four rules govern investment behavior in Islam according to Suleiman (2008):

1. The absence of interest-based (riba) transactions;

2. The avoidance of economic activities involving speculation (Gharar);

3. The introduction of an Islamic tax, zakat;

4. The discouragement of the production of goods and services which contradict the value pattern of Islamic (haram)

In the following part, the four elements⁷ that give Islamic Banking System its distinctive religious identity are mentioned:

Riba

The payment of riba and the taking as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an, and the Sunnah. So, the investors must be compensated by other means. Technically, riba refers to the addition in the amount of the principal of a loan (according to the time for which it is loaned) plus the amount of the loan. While earlier there was a debate as to whether riba relates to interest or usury, there now appears to be consensus of opinion among Islamic scholars that the term extends to all forms of interest.

In banning riba, Islam seeks to establish a society based upon fairness and justice (Qur’an 2.239). A loan provides the lender with a fixed return irrespective of the outcome of the borrower’s venture. It is much fairer to have a sharing of the profits and losses. Fairness in this context has two dimensions: the supplier of capital possesses a right to reward, but this reward should be commensurate with the risk and effort involved and thus be governed by the return on the individual project for which funds are supplied.

Hence, what is forbidden in Islamic is a predetermined return. The sharing of profit is legitimate and that practice has provided the foundation for Islamic Banking System.

Gharar

Another feature condemned by Islam is economic transactions involving elements of speculation, Gharar. Buying goods or shares at low and selling them for higher price in the future is considered to be illicit. Similarly an immediate sale in order to a void a loss in the future is condemned. The reason is that speculators generate their private gains at the expense of society at large.

Zakat

A mechanism for the redistribution of income and wealth is inherent is Islam, so that every Muslim is guaranteed a fair standard of living, nisab. An Islamic tax, Zakat (a term derived from the Arabic zaka, meaning “pure”) is the most important instrument for the redistribution of wealth. This tax is a compulsory levy, one of the five basic tenets of Islam and the generally accepted amount of the zakat is one fortieth (2.5 per cent) of Muslim’s annual income in cash or kind from all forms of assessed wealth exceeding nisab.

Every Islamic bank has to establish a zakat fund for collecting the tax and distributing it exclusively to the poor directly or through other religious institutions. This tax is imposed on the initial capital of the bank, on the reserves, and on the profits as described in the Handbook of Islamic Banking.

Haram

A strict code of ‘ethical investment’ operates. Hence it is forbidden for Islamic banks to finance activities or items forbidden in Islam, haram, such as trade of alcoholic beverage and pork meat.

Furthermore, as the fulfillment or materials needs assures a religious freedom for Muslims, Islamic banks are required to give priority to the production of essential goods which satisfy the needs of the majority of the Muslim community, while the production and marketing of luxury activities, israf wa traf is considered as unacceptable from a religious viewpoint.

In order to ensure that the practices and activities of Islamic banks do not contradict the Islamic ethical standards, Islamic banks are expected to establish a Sharia Supervisory Board, consisting of Muslim jurisprudence, who act as advisers to the banks.

2.1.3 OBJECTIVES OF ISLAMIC BANKING

The primary objective of establishing Islamic Banks all over the world is to promote, foster and develop the application of Islamic principles, law and tradition to the transaction of financial, banking and related business affairs and to promote investment companies, enterprises and concerns which shall themselves be engaged in business as are acceptable and consistent with Islamic principles, law and traditions. But the objectives of Islamic banking when viewed from the context of its role in an economy, its specific objectives may be enlisted as following (Akkas, 2008):

– To offer contemporary financial services in conformity with Islamic Shari’ah;

– To contribute towards economic development and prosperity within the principles of Islamic justice;

– Optimum allocation of scarce financial resources;

– Islamic Banking for equitable distribution of resources.

2.2 History of Islamic BANKING

2.2.1 Historical development

It seems that the history of interest-free banking could be divided into two parts. First, when it still remained an idea; second, when it became a reality — by private initiative in some countries and by law in others. We will discuss the two periods separately. The last decade has seen a marked decline in the establishment of new Islamic banks and the established banks seem to have failed to live up to the expectations. The literature of the period begins with evaluations and ends with attempts at finding ways and means of correcting and overcoming the problems encountered by the existing banks.

2.2.2 Interest-free banking as an idea

Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950 (1961). Muhammad Hamidullah’s 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognised the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha – profit and loss sharing.

In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.

Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process.

2.2.3 The coming into being of interest-free banks

The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait Finance House.

However, small scale limited scope interest-free banks have been tried before- one in Malaysia in the mid-forties and another in Pakistan in the late-fifties. But neither of them survived. In 1962 the Malaysian government set up the “Pilgrim’s Management Fund” to help prospective pilgrims to save and profit. The savings bank established in 1963 at Mit-Ghamr in Egypt was very popular and prospered initially and then closed down for various reasons. However this experiment led to the creation of the Nasser Social Bank in 1972. Though the bank is still active, its objectives are more social than commercial.

In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well: in Denmark, Luxembourg, Switzerland and the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined considerably in the following years.

In most countries the establishment of interest-free banking had been by private initiative and was confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The governments in both these countries took steps in 1981 to introduce interest-free banking. In Pakistan, effective 1 January 1981 all domestic commercial banks were permitted to accept deposits on the basis of profit-and-loss sharing (PLS). New steps were introduced on 1 January 1985 to formally transform the banking system over the next six months to one based on no interest. From 1 July 1985 no banks could accept any interest bearing deposits, and all existing deposits became subject to PLS rules. Yet some operations were still allowed to continue on the old basis. In Iran, certain administrative steps were taken in February 1981 to eliminate interest from banking operations. Interest on all assets was replaced by a 4 percent maximum service charge and by a 4 to 8 percent ‘profit’ rate depending on the type of economic activity. Interest on deposits was also converted into a ‘guaranteed minimum profit.’ In August 1983 the Usury-free Banking Law was introduced and a fourteen-month change over period began in January 1984. The whole system was converted to an interest-free one in March 1985.

2.2.4 The last decade

The subject matter of writings and conferences in the eighties have changed from the concepts and possibilities of interest-free banking to the evaluation of their performance and their impact on the rest of the economy and the world. Their very titles bear testimony to this and the places indicate the worldwide interest in the subject. Conference on Islamic Banking: Its impact on world financial and commercial practices held in London in September 1984, Workshop on Industrial Financing Activities of Islamic Banks held in Vienna in June 1986, International Conference on Islamic Banking held in Tehran in June 1986, International Conference on Islamic Banking and Finance: Current issues and future prospects held in Washington, D.C. in September 1986, Islamic Banking Conference held in Geneva in October 1986, and Conference ‘Into the 1990’s with Islamic Banking’ held in London in 1988 belong to this category. The most recent one is the Workshop on the Elimination of Riba from the Economy held in Islamabad in April 1992.

Several articles, books and PhD theses have been written on Islamic Banking during this period. Special mention must be made of the work by M. Akram Khan in preparing annotated bibliographies of all published (and some unpublished) works on Islamic Economics (including Islamic Banking) from 1940 and before. It is very useful to students of Islamic Economics and Banking, especially since both English and Urdu works are included (1983, 1991, and 1992). M.N. Siddiqi’s bibliographies include early works in Arabic, English and Urdu (1980, 1988). Turkish literature is found in Sabahuddin Zaim (1980).

2.3 ISLAMIC BANKING IN BANGLADESH AND ITS GROWTH

Islamic banking in Bangladesh began operation in Bangladesh in 1983, with a deposit of Tk 14 crore and investments of Tk 6 crore only. After its age 25 years, the total deposits of five major Islamic banks stand at Tk 27,000 crore and their investments exceed Tk 26,000 crore. A professor of Jahangirnagar University’s economics department, Professor Anu Muhammad, attributes the loyalty of the people to their religion to the huge growth of Islamic Banks in Bangladesh. He also thinks that the Islamic banks are much more organized than other banks in the private sector. Although the interest rate on loans is higher, many people sacrifice them only because of their loyalty towards the religion. As a result, many foreign banks owned and run by non-Muslims are now showing interest in the Islamic banking system. Now in Bangladesh, six banks fully conform to the Islamic banking system in the country -Islami Bank Bangladesh, Export Import Bank Bangladesh, Shahjalal Islami Bank, Al- Arafah Islami Bank, Social Investment Bank and ICB Islamic Bank.

There are also a number of non-banking Islamic financial institutions in the country. They include Islami Insurance, Islami Commercial Insurance, Tafakul Islami Insurance, Far East Islami Life Insurance, Prime Islami Life Insurance and Islamic Finance and Investment.

Besides, Prime, South East, Dhaka, City Bank, HSBC, Standard Chartered, Bank Al Falah, Premier and AB Bank operate 19 Islamic banking branches, while Bank Asia told bdnews24.com that it has also received permission to open two such branches.

According to Islami Bank Bangladesh, in 1983 when the bank first started its operations, total deposits were Tk 14 crore, with investments of just Tk 6 crore. Its foreign exchange business was worth Tk 1 crore at the time. At the end of 2007, the bank’s deposits stood at Tk 16,676 crore, investment at Tk 17,406 crore and the foreign exchange business is worth Tk 28,792 crore. Islami Bank recorded the rate of growth of deposits at 25.57 per cent in 2007 over the previous year. The rate of investment growth of the bank was 40.42 per cent in 2007, compared with the investment growth rate of 17.24 per cent in the banking sector the same year, according to available statistics. Of Islami Bank’s total investments in 2007, 51.43 per cent went into industries, 31.98 per cent into trade and commerce, 6.12 per cent into the real estate sector and 3.10 per cent into agriculture. Islami Bank’s business in the import, export and remittance sector in 2007 recorded a 42.66 per cent rise from a year ago, according to data provided by the bank.

In Islamic banking, the depositor takes an equal share of profit and loss. Besides, in conventional banking, there is no limit of interest. If one takes a loan and makes delays in repayment the amount of interest keeps on increasing. In Islamic banking, the system is different. Prof The aim of all banks is to collect deposits and make a profit through investment. Islamic banking is no different from conventional banking in profit making. Moreover, the profit rate charged or required on loans in Islamic banks is higher than in conventional banks. So they make more profit than interest based banks.

Al Arafah Islami Bank comes to illustrate the banking system’s popularity and success in Bangladesh, with an impressive deposit growth rate of 48.30 per cent, and an investment growth rate of 36.46 per cent over the past year. Shahjalal Islami Bank started its operations on May 10, 2001. In 2007, the bank’s deposits soared to Tk 2,262 crore, investments to Tk 2,062 crore, with Tk 2,835 crore in total assets.

Muhammad Ali, managing director of Shahjalal Islami Bank, believes Islamic banking is necessary for balanced distribution of wealth. Islamic banking also works towards the development of economic activities. That’s why people are becoming interested in this type of banking in Bangladesh.

2.4 The MAJOR MODES of Islamic banking and finance

Following are the main modes of Islamic banking and finance:

MURABAHA

The word “Murabaha” means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance.

IJARAH

Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.

IJARAH-WAL-IQTINA

A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does integral part of the lease contract to make it conditional. The rentals as well as the purchase not become a price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

MUSAWAMAH

Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to reveal his cost. Both the parties negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.

ISTISNA

It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Istisnaa can be used for financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways.

BAI MUAJJAL

Literally it means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal. It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It gin of profit is mutually agreed. The price fixed has to expressly mention cost of the commodity and the mar for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.

MUDARABAH

A form of partnership where one party provides the funds while the other provides expertise and management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a pre-agreed basis, while loss is borne only by the provider of the capital.

MUSHARAKAH

Musharaka means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.

BAI SALAM

Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies. Barring this, Bai-Salam covers almost everything, which is capable of being definitely described as to quantity, quality and workmanship.

2.5 DIFFERENCE BETWEEN THE INVESTMENT MODES OF CONVENTIONAL BANKING SYSTEM AND THOSE OF ISLAMIC BANKING SYSTEM

2.5.1 DISTINGUISHING FEATURES OF ISLAMIC BANKING

An Islamic bank has several distinctive features as compared to its conventional counterpart.

1. Abolition of (Riba): Since riba is prohibited in-the Holy Quran, and interest in all its form is included in the terminology of “RIBA” as confirmed by the authorized alims of ISLAM with few exceptions, the first distinguishing feature of an Islamic bank must be that it is interest-free, while the abolition of riba would be the first and essential difference between the conventional interest-based commercial banks and Islamic banks.

2. Adherence to Public Interest: The Islamic banks will serve public interest, not individual or group interest. The Islamic banks should use all deposits, which come from the public for serving public interest and realizing the relevant socio-economic goals of Islam. They should play a goal-oriented rather than merely a profit-maximizing role and should adjust themselves to the different needs of the Islamic economy.

3. Multi-purpose bank: Another substantial distinguishing feature is that Islamic banks will be universal or multi-purpose banks and not purely commercial banks. These banks are conceived to be a crossbreed of commercial and investment banks, investment trusts and investment management institutions, and would offer a variety of services to their customers. A substantial part of their financing would be for specific projects or ventures. Their equity-oriented investments cannot permit them to borrow short and lend long. This should tend to make them less crisis-prone compared to their capitalist counterparts. Since the overnight call loan or very short-term inter-bank market may be available to them only to a limited extent, they may have to make a greater effort to match the maturity of their liabilities with the maturity of their assets.

4. More Careful Evaluation of Investment Demand: Another very important feature of an Islamic bank is its very careful attitude towards evaluation of applications for equity oriented financing. It is customary that conventional banks evaluate applications, considers collateral, and avoid risks as far as possible. Their main concern does not go beyond ensuring the security of their principal and interest receipts. Since Islamic bank has in built mechanism of risk sharing, it would need to be more careful. It adds a healthy dimension in the whole lend business and eliminate a whole range of undesirable lending practices.

2.5.2 SIMILARITIES & DIFFERENCES

I- They are both financial intermediations. A financial intermediary is the institution that acts as a middleman between cash surplus units (savers) and deficit spending units (users of fund). It is quite obvious that the main function of conventional banks is financial intermediation. However, there are those who would like to think that there is no such thing in the Islamic economic system as financial intermediation and that an Islamic bank can only be “sufficiently” Islamic if it can operate like a trader, one who buys and sells goods and commodities. The financial intermediary in conventional banking is a “borrower-lender” institution. Since such institution will not survive unless it at least covers expenses, then an income must be generated from such arrangement. This is where interest appears. An Islamic bank, on the other hand, is based on a multi-tier Mudaraba. A Mudaraba is a partnership in profit where capital and management may joint together to create value. The income accruing to the Islamic financial intermediary is coming out of profit not from interest. The root of such a conception is the fact that Shari’ah doesn’t distinguish between a seller being a trader or a final intermediary, unlike positive law where civil law is different from commercial law. In Shari’ah all people stand against one legal code.

II- A case in mind is Murabaha. There are those who say if an Islamic bank does Murabaha any other form but the traders’ way of doing things it will not be permissible from Shari’ah point of view, and an Islamic bank would be in their view a “dubious” conventional bank. They say: since it is never the intention of the bank, to own there assets and hold on to them then, such bank is not sufficiently Islamic.

According to this viewpoint, an Islamic bank must have huge warehouses and elegant stores full of goodies for sale. This is not valid and those who think so miss two important points:

Intention is of no consequence on the permissibility or otherwise of any exchange contract in Shari’ah. In an authentic Hadith, the Prophet (PBUH) showed one companion how to substitute a usurious transaction by another non usurious to reach the same purpose, He (PBUH) didn’t object to the intention nor that he nullified the contract on the basis of intention. Rather he corrected the form of contract.

If the anatomy of the contract is in line with Shari’ah requirements, then the transaction is acceptable. Hence, if bank actually buys and then sells, with ownership passing from seller to buyer and that the subject of contract is a good or commodity then the transaction is correct. In conventional banking the subject of contract is money hence any increase is usurious.

III- The way conventional banks render financial intermediation is very simple. They borrow money and lend money. Both assets and liabilities are one form of lending. Islamic banking functions in a rather “elaborate” (not perplexing) way. They have to continuously innovate to satisfy the needs of their clients. It is because of this we see Murabaha, Musharakah, Mudarabah, Istisnaa, and Salam to name just a few Islamic modes of finance. This makes the job of an Islamic banker “not all roses”, but certainly a more interesting one.

IV- A conventional banker is a risk manger. He is concerned with all kind of credit, market, interest rate, legal and other risk factors. An Islamic banker should be just as concerned. However, there is one added risk for the Islamic banker, this is what we may call “Shariah inobservance risk”. Risk analysis refers to the forces that may cause the outcome of investment to be sub optimal. Certainly an Islamic investor earning non-permissible income is an outcome that is most undesired, and it may cause the value of his investment to be reduced.

V- Contrary to popular opinion, being concerned about time value of money is a similarity not a difference between Islamic and conventional banking. There is no basis for the current thinking that Shariah doesn’t allow the attachment of monetary value to time in the contracts exchange. The contracts of Salam and differed-payment sales fly in the face of this argument. It is only in loans that Shariah requires that no time value of money is considered (but replaced by great rewards in the hereafter).

VI- A major difference, however, remains in the handling of delinquency and default. When a borrower delays payment of debt, interest will accrue on his delayed portion. Unless, such borrower defaults and become incapable of paying back his debt, such interest will compensate the conventional bank for lost business. This can’t be done in Islamic banking, as this is considered usurious.

Clearly, this is a disadvantage from two aspects: Firstly, an Islamic bank will not have the opportunity in a Murabaha transaction for example, to be compensated for lost profit. But more importantly, it increases significantly, the Murabaha risks. Since bank clients are rational people who will seize an opportunity when they see one, they will always delay payment. One major Ijtihad of contemporary Shariah scholars is to allow the Islamic bank to impose penalties. Rather than accrue such penalties as income, and hence become usurious, they are disposed off to charity. This way the pressure will mount on the debtor to pay in time, without falling into Shariah impressibility.

However, the differences are presented in a tabular format below:

CHAPTER 3: PROFILE OF SHAHJALAL ISLAMI BANK LIMITED

3.1 OVERVIEW OF SHAHJALAL ISLAMI BANK LIMITED

Shahjalal Islami Bank limited, a Shariah Based Commercial Bank in Bangladesh was incorporated as a Public limited company on 1st April, 2001 under Companies Act 1994. The Bank commenced commercial operation on 10 May, 2001 by opening its branch, i.e. Dhaka Main Branch at 58, Dilkusha, Dhaka obtaining the license from Bangladesh Bank, the Central Bank of Bangladesh. Its corporate Head Office is situated at 10, Dilkusha Commercial Area, Jiban Bima Bhaban, Dhaka-1000, Bangladesh. The Bank opened 2 (two) branches in 2001, 6 (six) branches in 2002, 2 (two) branches in 2003, 2 (two) branches in 2004, 4 (four) branches in 2005 and 5 (Five) Branches in 2006. Total number of branches stood at 21 (Twenty One) in 2006 and 5 (five) more branches will be opened in important business locations of the country during 2007.

Shahjalal Islami Bank Limited is one of the few banks permitted by the Bangladesh bank in the early 2000s; the other banks permitted earlier were Social Investment Bank Limited, First Security Bank Limited, Eastern Bank, Bank Asia, Jamuna Bank. These banks are known as the third generation banks and fortunate to remain immune from the bad loan culture. However, the performances of these banks are not the same, The Government of Bangladesh as a Scheduled Bank in the private sector has licensed Shahjalal Islami Bank Limited in pursuance of the policy of liberalization of banking and financial services and facilities in Bangladesh. In view of the above, the Bank within a period of 5 years of its operation achieved a remarkable success and met up capital adequacy requirement of Bangladesh bank. It has been growing faster as one of the leaders of the new generation banks in the private sector in respect of business and profitability as it is evident from the financial statements for the last 2 years.

3.2 Review of Operational Performance

During the year under review, the bank through its Twenty-one branches mobilized Deposit of Tk. 18,091 million and deployed Tk. 15,516 million in investment as on 31.12.2006. Total income of the Bank was Tk. 2,563 million and total expenditure stood at Tk. 1,718 million, resulting in Operating Profit of Tk. 845 million. The Bank handled total Foreign Exchange Business of Tk. 33,501 million in the year 2006.

3.3 Special Features of the Bank

• It has been performing Islamic commercial banking activity and striving to introduce dynamic Banking functions.
• It is the pioneer in introducing and launching different customer friendly deposit schemes to tap the savings of the people for channel sings the same to the productive sectors of the economy.
• For uplifting the standard of living of the limited income group of the population the Bank has introduced Consumer Credit Schemes by providing financial assistance in the form of loan to the consumers for procuring household durables, which have had encouraging responses.
• The Bank is committed to continuous research and development so as to keep pace with Islamic banking.
• The operations of the Bank are fully computerized so as to ensure quick, prompt flawless and services to the customers.
• The Bank has introduced camera monitor system (CCTV) to strengthen the security services inside the Bank premises.

3.4 Objectives of the organization

From time immemorial Banks principally did the functions of moneylenders or “Mohajans” but the functions and scope of modern banking are now a days very wide and different. They accept deposits and lend money like their ancestors, nevertheless, their role, as catalytic agent of economic development encompassing wide range of services is very important. Business commerce and industries in modern times cannot go without banks. There are people interested to abide by the injunctions of religions in all sphere of life including economic activities. Human being is value oriented and social science is not value-neutral. Shahjalal Islami Bank believes in moral and material development simultaneously. “Interest” or “Usury” has not been appreciated and accepted by ‘the Tawrat” of Prophet Moses, “the Bible” of Prophet Jesus and “the Quran” of Hazrat Muhammad (Sm). Efforts are there to do banking without interest Shahjalal Islami Bank Limited avoids “interest” in all its transactions and provides all available modern banking services to its clients and want to contribute in both moral and material development of human being. No sustainable material well-being is possible without spiritual development of mankind. Only material well being should not be the objective of development. Socio-economic justice and brotherhood can be implemented well in a God fearing society.

Other objectives of Shahjalal Islami Bank include:

• To establish interest-free and welfare oriented banking system.

• To help in poverty alleviation and employment generations.

• To contribute in sustainable economic growth.

3.5 History of the organization

Privatization of Banking is an outcome of the deliberate policy change by the government of Bangladesh in the late 1970. The emergence of Shahjalal Islami Bank Limited (SJIBL) was at the juncture of liberalization of global economic and Islamic activities, after the URUGUAY ROUND has been an important event in the financial sector of Bangladesh. The experience of the prosperous economies of the Muslim countries, in particular of South Asia, has been the driving force and the strategic operational policy option of the bank. The company philosophy – “A Bank with Shariah-Based on Banking” has been precisely an essence of the legend of success in the Muslim countries.

Shahjalal Islami Bank Limited is named after the name of a saint Hajrat Shahjalal who dedicated his life for the cause of peace in this world and hereafter and served the humanity. The prime objective of Shahjalal Islami Bank is to serve the people for attainment of their economic goal and success in life here and hereafter. Shahjalal Islami Bank stands not only for material well-being but also for ethical development of its customers.

The Government of Bangladesh has licensed Shahjalal Islamic Bank Ltd. (SJIBL) as a private commercial bank, which is focused on the established and emerging markets of Bangladesh. The bank was incorporated in Bangladesh as a public limited company on April 01, 2001 under company Act 1994, and started banking operations through the “Dhaka Main Branch” at 58 Dilkusha C/A, Dhaka-1000 on May 10, 2001.

3.6 Functions of Shahjalal Islami Bank Limited

The primary function of SJIBL is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the functions of SJIBL when viewed in the context of its role in the economy are listed as follow:

• Conduct interest-free banking.

• Establish participatory banking instead of banking on debtor-creditor relationship.

• Invest through different modes permitted under Islamic Shariah.

• Accept deposits on profit-loss sharing basis.

• Establish a welfare-oriented banking system.

• Extended co-operation to the poor, the helpless and the low-income group for their economic upliftment.

• Play a vital role in human development and employment generation.

• Contribute towards balanced growth and development of the country through investment operations particularly in the less developed areas.

• Contribute in achieving the ultimate goal of Islamic economic system.

3.7 Divisions of Shahjalal Islami bank Ltd

The Head Office of Shahjalal Islami bank has nine major divisions and each comprising of various departments. The major divisions in the Head Office are as follows:

3.7.1 Investment Division

This division has the authority to determine the party or the client who will get the credit facility from the bank. The credit clients are selected according to the criteria of credit policy. This division has the full authority to take any decision against or favor the client and the Credit Services Division supports these divisional works.

3.7.2 Financial Administration Division

This division handles the credit proposal, disbursement, monitoring and credit recovery position that is given by all branches. Each branch has their own credit division and all branch-wise activities are reported to the head office credit services division.

3.7.3 Audit & Inspection Division, H.O

This division can control all the financial position, activities of overall organization. They provide the total budgetary limitation to every department for the respective year. They also carry out the financing activities with the access and operational activities.

3.7.4 Marketing & Public Relation Division

This division mainly works

• To improve the marketing network through out the country

• To implement the marketing strategies and the concept of Trade Marketing

• To improve the procedure which is ultimately provide date regarding to competition and relative market

• To arrange of several workshops and seminar which can, improve the quality of existing officers as a competitive edge position

3.7.5 Common Services Division

This division handles all the general activities except the credit and financial sector. All the administration activities arc designed and implemented by this division.

3.7.6 Human Resource Division (Hrd)

This division deals with the employees as the core resources of the organization. They mainly emphasize on the recruitment of employees and the employee benefits & services. And, the main philosophy is to motivate the employee to work with efficiently and effectively.

3.7.7 Computer It Division (IT)

This division handles the IT activities. Each branch has their own IT division and all branch-wise activities are reported to the head office IT division.

3.7.8 International Division

This division works internationally. The entire branch-wise international work is controlled and monitored by this division.

3.8 Performance of the Bank

The Shahjalal Islami Bank Limited (SJIBL) was incorporated as a public limited company on April 01, 2001 under Companies Act. 1994. The bank started commercial banking operations effective from May 10, 2001. During this short span of time the bank of time the Bank had been successful to position itself as a progressive and dynamic financial institution in the country. The Bank had been widely acclaimed by the business community from small businessmen / entrepreneurs to large traders and industrial conglomerates, including the top rated corporate borrowers for forward-looking business outlook and innovative financing solutions. The operating profit of the Bank in the year 2007 was appreciable. Total equity of the Bank as on 31.12.2005 was Tk. 848.35 million and the total equity stood to Tk. 1,362.57 million on 31.12.2006, which was 10.39% of the Risk Weighted Assets as against the requirement of 9.00%. The core capital was 9.19% of Risk Weighted Assets as on 31 December 2006 as against requirement of 4.50%. After IPO, as on 30.06.2007, total equity stands at Tk. 2,545.30 Risk Weighted Assets as against total requirement of 9%.

3.9 Equity of the Bank

The Authorized Capital of the Bank is Tk. 2,000 million and paid-up capital of the Bank is Tk. 936 million as on 31.12.2006. Total equity was Tk. 1,363 million as on 31.12.2006. The Bank has already raised its paid up capital of Tk. 936 million through Initial Public Offering (IPO) in January-February 2007. After IPO Bank’s paid-up capital stands at Tk. 1,872 million in February 2007. Comparative position of Equity for the year 2006 & 2005 is given below: (Amount in million Taka):

3.10 Capital Adequacy

Total equity of the Bank as on 31.12.2005 was Tk. 848.35 million and the total equity stood to Tk. 1,362.57 million on 31.12.2006, which was 10.39% of the Risk Weighted Assets as against the requirement of 9.00%. The core capital was 9.l9% of Risk Weighted Assets as on 31 December 2006 as against requirement of 4.50%.

After IPO, as on 30.06.2007 total equity stands at Tk. 2,545.30 million, which was 17.73% of Risk Weighted Assets as against total requirement of 9%.

3.11 Basel II preparation

Under the Basel II initiative, which is intended to ensure that banks have enough capital to cover their risks, a bank’s regulatory capital will be tied directly to its internal risks and its choices in managing them- the lower the risks and the better the risk management, the lower the regulatory capital requirement. Moreover, Basel II introduces an array of approaches to measuring credit and operational risk that enables banks to adopt methodologies that best suit their organization and risk profile.

The Basel II framework describes a more