2. INTRODUCTIONINTRODUCTION
Islamic banking is interest free banking, in which
there is no fixed rate of return.
Islamic banking is guided by Islamic law ( Shari a`)
principles and guided by Islamic economics.
In particular, Islamic law prohibits usury, the
collection and payment of interest, also
commonly called Riba in Islamic discourse.
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3. TERMINOLOGIESTERMINOLOGIES
Takaful (Islamic Insurance) is a co-operative system of reimbursement, paid to
people and companies in case of hazards & misfortunes. It is compensated out of a
fund to which they agree to donate small regular contributions.
Murabaha
It is a contract for purchase and resale and allows the customer to make purchases
without having to take out a loan and pay interest.
Bank purchases the goods on behalf of the customer, and re-sells them to the
customer on an agreed profit margin and the customer pays the sale price for the
goods over installments.
Riba and Gharar are illegal under Islamic law.
Riba refers to fixed rate of interest. Gharar refers to speculation.
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4. Shariah ( Islamic Law)
Shariah means a way(or)path.
In Islam Shariah refers to the divine
guidance and laws given by the Holy
Quran, the sayings of the Prophet
Muhammad along with interpretations
given by Islamic Scholars.
Shariah embodies all aspects of the Islamic
faith, including beliefs and practices.
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5. Ijarah
Ijara is a form of leasing.
It involves a contract where the bank buys and then leases an
item.
For example: auto ijarah is simply an agreement under which
the vehicle shall be given to you on rent for a period, agreed
at the time of the contract. Bank purchases the vehicle and
lease it out to the consumer for the agreed period.
Musharaka
It means partnership. It involves placing your capital with
another person and sharing the risks and rewards in profit
sharing ratio, but losses must be proportionate to the capital
invested.
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7. Individual freedomIndividual freedom
Every individual enjoys freedom of
thought , speech & expression. Islam
always cares about the freedom of life
irrespective of gender, race & religion.
Social rights
Islam imposes social right over
individual’s wealth in various forms, for
example the rights of kindred, rights of
neighbors, rights of the poor and
spending in the way of Allah.
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8. Equitable distribution ofEquitable distribution of
income and wealthincome and wealth
It lays down certain regulations for
the maintenance of equity such as
distinction between lawful and
unlawful means of income, right of
free enterprise for individuals and
right to keep the lawfully earned
wealth
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9. Principle of the ultimatePrinciple of the ultimate
ownership and theownership and the
concept of vicegerenceconcept of vicegerence
Allah is the creator and ultimate owner
to the universe. These principles ensure
the banks will fulfill the responsibility of
investing their own capital as well as
others according to the syariah.
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10. Principle of integratingPrinciple of integrating
every activity with theevery activity with the
morale valuemorale value
Ethical behaviors are one of the most
important injunctions of the Islamic
shariah. Islam does not only promote
good ethical and moral behavior, it
strongly prohibits unethical and
immoral behaviors of all sorts.
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Conventional BanksConventional Banks Islamic BanksIslamic Banks
Money is a commodity besides medium ofMoney is a commodity besides medium of
exchange and store of valueexchange and store of value
Money is not a commodity thought it isMoney is not a commodity thought it is
used as a medium of exchange and storeused as a medium of exchange and store
of valueof value
Time value is the basis for charging interest onTime value is the basis for charging interest on
capitalcapital
Profit on trade of goods for charging onProfit on trade of goods for charging on
providing service is the basis for earningproviding service is the basis for earning
profitprofit
Interest is charged even in case theInterest is charged even in case the
organization suffers losses by using bank’sorganization suffers losses by using bank’s
fundfund
Islamic bank operates on the basis ofIslamic bank operates on the basis of
profit and loss sharingprofit and loss sharing
While disbursing cash finance, running financeWhile disbursing cash finance, running finance
or working capital, no agreement for exchangeor working capital, no agreement for exchange
of goods & services is made.of goods & services is made.
The execution of agreements for theThe execution of agreements for the
exchange of goods & services is a mustexchange of goods & services is a must
while disbursing funds under Murabaha,while disbursing funds under Murabaha,
salam & Istisna contractssalam & Istisna contracts
Lending money and getting it back withLending money and getting it back with
compounding interest is the fundamentalcompounding interest is the fundamental
functions of the conventional banksfunctions of the conventional banks
Compounding calculation is strictlyCompounding calculation is strictly
prohibited under Islamic banking systemprohibited under Islamic banking system
15. Nature of deposits in Islamic Banks
Mudarabah is a special kind of partnership
where one partner providers the capital to
the other for investment in a commercial
enterprise.
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DepositDeposit NatureNature
CurrentCurrent QarzQarz
SavingSaving MudarabahMudarabah
16. ISLAMIC BANKING AS ANISLAMIC BANKING AS AN
ALTERNATIVE APPROACHALTERNATIVE APPROACH
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17. For Muslims, this system of profit/loss sharing coincides with
their belief in the prohibition of interest, and helps in mobilizing
unused funds for investment and creating new job opportunities.
As for non-Muslims, the Islamic banking system does not
contradict their faith, while it provides the society with
alternative ideas for venture capital and other tools of
investment.
Mudarabah as a contract of participation between the provider
of capital and the managing entrepreneur responds to normal
human needs.
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18. The ultimate test of such alternative is whether it is successful or
not. It can be safely said that the idea of Islamic banking has been
successful.
Islamic banking was partially practiced by some of the Western
banks and financial institutions in Switzerland, U.K. and the
United States.
Economists have proven that the wider is the freedom of choice
the higher is the level of social welfare. In addition, wider choice
implies greater respect of human rights. When an alternative
concept such as Islamic banking is introduced, a new choice is
open to the market, with obvious economic and social benefits.
Introducing Islamic banking as a new choice has also further
benefits related to the advantages it provides to many fund users.
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19. Commodity and service producers would certainly
appreciate equal opportunities for obtaining capital
based on the merits of their businesses rather than on
their personal creditworthiness alone.
Those entrepreneurs who prefer to be self employed
need ways to obtain financing other than borrowing.
Islamic banking gives those pioneers such an
opportunity on the basis of profit/loss sharing.
In general, Islamic finance places more weight on the merit of the
business to be financed, rather than the wealth of the fund user.
As a result under this new banking alternative, a better
distribution of credit may be achieved.
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21. The biggest challenge Islamic banks have faced from their very
beginning is how to narrow the gap between the Islamic banking
model and its application; in other words, between theory and
practice.
Difficulties come from being relatively small in a traditional
banking environment, having to rely on bankers trained in
traditional banking, and attempting to balance the unquenchable
enthusiasm on the side of depositors, with a limited supply of
investment opportunities.
Islamic banks have been trying hard to meet these challenges
through several means. The first is to work for a better
understanding of the concepts upon which their operations are
based. This has been a success to the extent that now traditional
bankers are mostly cooperative and accommodating.
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22. Another means is to train their staff in this new form of banking
and to press for more banking and financial innovations which are
necessary for the new modes of finance. Fortunately, financial
engineering has come in handy with bold and new ideas in finance
which made the Islamic model so much more applicable.
Surprisingly, financial markets produced some useful innovations,
perhaps indicating that Islamic banking is an idea whose time has
come. The prospects of Islamic banking and finance will depend
extensively on the ability of Islamic banks to continue facing
challenges with resourcefulness and creativity, in addition to
being worthy of trust and understanding. I believe that
competition, if allowed and maintained, not only within Islamic
banks, but also between all banks whether Islamic or traditional,
would insure a promising future for the banking industry as a
whole.
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