Explain what Islamic Banking is and its background.
Islamic banking is a banking system that follows the Islamic rules (Shari'ah) and principles which emphasize in moral and ethical values. The system was formed in the late 20th century when a group of Islamic banks were created to provide an alternative to Muslims, but it is important to say that these banks can be used by non-Muslim people as well. Islamic banks have the same purposes as the non Islamic banks, but they differ because the first ones comply with the rules of Shari’ah.
The main source for Islamic Banking is The Koran, followed by the sayings of Prophet Muhammad; in case that a problem does not find the solution in these two sources, a group conformed by scholars, independent reasoning of an Islamic scholar and custom must reach a consensus to provide the needed rules.
It is said that Islamic banking began with Prophet Muhammad himself, when he acted as an agent for the trading operations of his wife; but it was not until late 20th century that the Islamic Banking really developed when in 1963 the first Islamic bank free of interests started operations in Egypt.
The main source for Islamic Banking is The Koran, followed by the sayings of Prophet Muhammad; in case that a problem does not find the solution in these two sources, a group conformed by scholars, independent reasoning of an Islamic scholar and custom must reach a consensus to provide the needed rules.
It is said that Islamic banking began with Prophet Muhammad himself, when he acted as an agent for the trading operations of his wife; but it was not until late 20th century that the Islamic Banking really developed when in 1963 the first Islamic bank free of interests started operations in Egypt.
What are the key principles of Islamic banking?
· Investments must be approved by and independent Shari’ah supervisory board in order to ensure that the investment is completely adhered to Shari’ah principles. If a deviation occurs, the business practice must be penalized; in Islamic finance penalties must be paid to charity.
· Investments with interests, gambling and speculation are prohibited because they are considered as exploitation.
Islamic law forbids institutions from charging interests on loans. How do they make profits when lending money?
§ Safekeeping (Wadiah): The person places the money in a bank and the bank guarantees to return the money anytime the person wants it. The bank may charge the person a fee for looking after his money and the bank may also pay gifts (hibah) to the person.
§ Profit Sharing (Mudharabah): It is a profit sharing arrangement between an entrepreneur and an investor. The investor will supply the entrepreneur with funds for his business venture and gets a return on the funds he puts into the business based on a profit sharing ratio that has been agreed earlier. This principle can be applied to Islamic banking operations in 2 ways: between a bank (as the entrepreneur) and the capital provider, and between a bank (as capital provider) and the entrepreneur. Losses suffered shall be borne by the capital provider.
§ Deferred Payment Sale (Bai’ Bithaman Ajil): A person picks an asset he would like to buy. The person asks the bank for a deferred payment sale and promises the bank to buy the asset from the bank at a mark-up price. The bank buys the asset and gets the ownership of it. Then the bank sells the good to the person at the established mar-up price. The person pays the price in installments over a period of time.
§ Cost Plus (Murabahah): this transaction involves the sale of goods at a price which includes a profit margin agreed by both parties. However, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement.
§ Joint Venture (Musyarakah): refers to a partnership or a joint business venture to make profit. Profits made will be shared by the partners based on an agreed ratio which may not be in the same proportion as the amount of investment made by the partners. However, losses incurred will be shared based on the ratio of funds invested by each partner.
§ Hire Purchase (Ijarah Thumma Bai’): it is normally used in financing consumer goods especially motor vehicles. There are two separate contracts involved: Ijarah contract (leasing/renting) and Bai’ contract (purchase).
Explain the concept of ethical investments under Islamic law. Who is to determine whether an activity is allowed or not?
Ethical investments under Islamic law are all those permitted by the Shari’ah, those who does not go against Shari’ah principles.
All Islamic banks have set up Shari’ah Committees to guide them on Shari’ah matters and to make sure that they function in a manner that is in line with the Shari’ah. In addition, the advice of the Shari’ah Advisory Council which is the highest Shari’ah body can be sought to ensure uniformity in views and practices. The members of the Shari’ah Committees and the Shari’ah Advisory Council are academicians and Shari’ah experts in Islamic banking and finance. The Supervisory Board must be comprised of at least three Shari’ah scholars with specialized knowledge of the Islamic laws for transacting.
How does Islamic banking influence the economy in the Middle East?
“Islamic banking is an instrument for the development of an Islamic economic order.” (www.islamic-banking.com).
- "While permitting the individual the right to seek economic well-being, Islam makes a clear distinction between what is halal (lawful) and what is haram (forbidden or unlawful) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious."
- "While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it."
- "While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat (a tax on wealth that is distributed to the needy)."
- "While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance."
- "Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive."
(taken from http://www.islamic-banking.com/)
Based on your research and knowledge about this topic, what is the future of Islamic Banking in terms of global expansion and growth?
I think that Islamic Banking will continue growing and expanding in the world for several reasons. First I think that globalization has brought to the countries lots of people coming from different cultures, and Islamic culture is not the exception. With Muslims travelling and establishing in different countries it is very possible that Islamic banks will create subsidiaries to attend the market.
Second I think that Islamic banking provides an alternative for people and since those banks are not exclusive for Muslims they could become an interesting alternative for those who perceive regular banks as more than “fierce” capitalism that take advantage of the people charging them with huge interests.
BIBLIOGRAPHY
http://www.islamic-banking.com/. April 30, 2010
Islam’s approach to ethical investment. [http://islamicfinancenews.wordpress.com/]. May 3, 2010
Basic concepts and Principles of Islamic Banking.[http://www.bankinginfo.com.my/] May 3rd, 2010
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