Islamic banking

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Islamic banking refers to a system of banking or banking activity which is consistent with Islamic law (Sharia) principles and guided by Islamic economics. In particular, Islamic law prohibits the collection of interest, also commonly called riba in Islamic discourse. One form of the argument against interest is that money is not a good and profit should be earned on goods and services only; not on control of money itself. (Return on Assets). On the other hand, Islamic banking promotes profit sharing in the conduct of banking business.

While Islamic law prohibits the collection of interest it does allow a seller to resell an item at a higher price than it was bought for, as long as there are clearly two transactions. As an example of how riba is treated is contained in Sahih Bukhari Hadith, Book 3 [1] ( 382)

Narrated Ibn Shihab: That Malik bin Aus said, "I was in need of change for one-hundred Dinars. Talha bin 'Ubaidullah called me and we discussed the matter, and he agreed to change (my Dinars). He took the gold pieces in his hands and fidgeted with them, and then said, "Wait till my storekeeper comes from the forest." 'Umar was listening to that and said, "By Allah! You should not separate from Talha till you get the money from him, for Allah's Apostle said, 'The selling of gold for gold is Riba (usury) except if the exchange is from hand to hand and equal in amount, and similarly, the selling of wheat for wheat is Riba (usury) unless it is from hand to hand and equal in amount, and the selling of barley for barley is usury unless it is from hand to hand and equal in amount, and dates for dates, is usury unless it is from hand to hand and equal in amount.' "

In other words, to perform a single transaction where one person trades one kind of thing (such as gold, grapes, wheat, or barley) for more or less of the same kind of thing, is exactly what has been disallowed. To purchase something from someone at one price and sell it to someone else at a higher price, incorporating profit, is allowed as long as the business is lawful.


Principles in Islamic Banking

Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah) and leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money, a bank might buy an item from the seller, and sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. The higher cost might include what would in non-Islamic arrangements have been charged as interest, but there could not be additional penalties for late payment. This arrangement is called Murabaha. Another approach is Ijara wa Iqtina, which is similar to real estate leasing.

In business deals there are several other approaches to handle a lack of interest. Most important is Musharaka, which is equity financing. Further Mudaraba means if one entrepreneur is doing the work and the other is giving the funds to finance it then both profit and risk must be shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, as it is Allah who determines that failure, and intends that it fall on all those involved. So venture capital and even micro venture capital are fine, but not loans.

Last, but not least, Islamic Banking is restricted to Islamically acceptable deals, which exclude e.g. alcohols, pork, gambling etc. Thus ethical investing is the only acceptable investing, and moral purchasing is encouraged.

Islamic banks have grown recently in the Muslim world but are a very small share of the global economy compared to the Western debt banking paradigm. Micro-lending institutions such as Grameen Bank use conventional lending practices, and are popular in some Muslim nations, but are clearly not Islamic banking.

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to establish Shariah advisory committees/ consultants to advise them and to ensure that the operations and activities of the bank comply with Shariah principles.

In Malaysia, the National Syariah Advisory Council additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Shariah aspects of the operations of these institutions, as well as on their products and services. (See: Islamic banking in Malaysia)

Concepts In Islamic Banking

Wadiah (Safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the whole amount of the deposit, or any part of the outstanding amount, when the depositor demands for it. The depositor, at the bank's discretion, may be rewarded with 'hibah' (gift) as a form of appreciation for the use of funds by the bank.

Mudharabah (Profit Sharing)

Mudharabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity. Any profits made will be shared between the capital provider and the entrepreneur according to an agreed ratio while losses are borne solely by the capital provider.

Musharakah (Joint Venture)

This concept is normally applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio while losses incurred, will be divided based on the equity participation ratio.

Murabahah (Cost Plus)

The selling of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement.

Bai' Bithaman Ajil (Deferred Payment Sale)

The selling of goods on a deferred payment basis at a price, which includes a profit margin agreed by both parties.

Wakalah (Agency)

When a person appoints a representative to undertake transactions on his/their behalf.

Qardhul Hassan (Benevolent Loan)

A loan extended on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrower may, at his discretion, pay extra (without promising it) as a token of appreciation.

Ijarah Thumma Al Bai' (Hire Purchase)

There are two contracts involved in this concept. The first contract, Ijarah contract (leasing/renting) and the second contract, Bai' contract (purchase) are undertaken one after the other. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed rental over a specific period. When the leasing period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price.

Bai' al-Inah (Sell and Buy Back Agreement)

The financier sells an asset to the customer on a deferred payment and then the asset is immediately repurchased by the financier for cash at a discount.

Hibah (Gift)

A token given voluntarily in return for loan given or benefit obtained.

See also

By country:


ja:イスラム銀行 eo:Islama banko


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