Understanding Islamic Banking
What is Islamic Banking?
Islamic banking is a system of conducting banking activities in line with the principles of Shariah while avoiding all the prohibited activities such as
Interest/Riba, Gharar* (uncertainty), dealing in prohibited businesses (e.g. alcohol, gambling), etc.
‘Interest free banking’ is one of the key principles of Islamic banking. It allows you to avoid interest-based transactions, but in addition, also avoid unethical and socially unacceptable practices prohibited under in Shariah, including: unfair trade practices, hoarding, speculation…etc.
Therefore, Islamic banking transactions are based on ‘tangible assets and real services’ as opposed to ‘conventional money lending’
* Gharar: The uncertainty that is present in the basic elements of an agreement (i.e. wording of the agreement, subject matter, etc.)
Is Islamic banking meant only for Muslims?
The teachings of Islam are meant for both Muslims and non-Muslims. Universal values like honesty, justice, avoiding fraud, etc., form the basic principles of Islamic banking. Therefore, Islamic banking is for everyone irrespective of what religion they follow.
What is meant by Shariah?
Shariah means a “Way” or “Path”. In Islam, Shariah means guidance and laws given by the Holy Quran and the Hadith/Sunnah of the Holy Prophet (Peace Be Upon Him). It also includes juristic interpretations of Islamic scholars. Islamic Shariah is derived from the following four sources:
- The Holy Quran
- The Sunnah of the Holy Prophet (Peace Be Upon Him)
- Ijma’ (consensus of the Mujtahideen - ‘Independent Jurists’)
- Qiyas (Analogy)
What is Riba or Interest?
"Riba" means excess, increase or addition. As per Hadith of the Holy Prophet (Peace Be Upon Him), “Every loan that derives a benefit (to the lender) is Riba”. Therefore, interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it has the same meaning as that of Riba.
Are Islamic banks not just paying interest and dressing it as profit on trade and investments?
This is not the case. Islamic banks accept deposits from customers on profit and loss sharing or on the basis of “Qard”. These funds are used in Shariah compliant modes of finance, trade or investment. The income generated by these Shariah compliant modes are then distributed among the depositors as profit
The main differentiating points between conventional banking and Islamic banking are:
|CONVENTIONAL BANKING||ISLAMIC BANKING|
|1||Money is a commodity as well as a medium
of exchange. Therefore, it can be sold at a
price higher than its face value and it can
also be rented out.
|Money is not a commodity. It is only used as a
medium of exchange. Therefore, it cannot be sold
at a price higher than its face value or rented out
|2||Profit is earned by charging interest on
capital. ‘Time value’ is the basis for charging
interest on money/capital.
|Profit is earned through trade of goods
.or charging for providing services.
|3||Interest is charged even in case the
organisation suffers losses by using the
bank’s funds. Therefore, it is not based on
profit and loss sharing.
|Islamic banks may operate on the basis of profit
and loss sharing. If the business has suffered
losses, the bank will share these losses based on
the mode of finance used (e.g. Mudarabah and Musharakah).
|4||While disbursing cash finance, running
finance or working capital finance, no
agreement for exchange of goods and
services is made.
|The execution of agreements for the exchange of
services is a must while disbursing funds under
Murabaha, Salam and Istisna contracts
|5||Conventional banks use money as
a commodity which leads to inflation.
|Islamic banking tends to create link with the real
sectors of the economic system by using trade
related activities. Since money is linked with real
assets, it contributes directly to economic