BANKING IN ISLAM

FINANCING DURING THE PROPHETS ERA

Trade was the main economic activity of the tribe of Quraish during the Prophets (pbuh) time. During his time people were trading through riba (before it was prohibited) and mudarabah, bai al-salam, etc.

ISLAMIZATION OF THE CONVENTIONAL BANKING SYSTEMThe Islamization of the modern banking system started as an idea in Egypt. This idea was to introduce interest-free banking on the basis of profit sharing rather than interest, which was prohibited by Islam. The first Muslim economist to introduce such an idea of interest-free banking, was Professor Ahmed Al-Naggar who is known as The Founder of Islamic Banks. His idea was put into practice in a savings bank, at Mit-Ghamr, in Egypt in 1963. However, this bank was closed due to various political reasons.

ISLAMIZATION OF THE CONVENTIONAL BANKING SYSTEMIn the early seventies many conferences were held regarding these issues in different Muslim countries. Owing to the oil boom in1973 and massive accumulation of petro dollar surpluses in the Middle East after, the first established Islamic Commercial Bank was Abu Dhabi Islamic Bank in 1977, followed by the Faisal Islamic Bank in Sudan in 1978. This was soon followed by the establishment of a whole group of Faisal Islamic Banks in many Muslim countries.

MOTIVES OF FINANCING According to ibn Hazm (456H) he stated that all those who could not afford the mental and physical strain and hardship of trading had to rely on some kind of financing in order to earn their livelihood.

What are the motives of financing?Means of cooperation and relieving ones Muslim brother hardship Human desire to make ones wealth grow

PRINCIPLES OF FINANCING The principle of sharing the net outcome of an enterprise or business transaction by the financier and the user of funds as in mudarabah.

The principle of sharing the gross output while operating costs are borne by one party and are naturally considered in the distribution of shares in the agreement.

The principle of financing through sale.

DIFFERENCE BETWEEN SALE AND INTERESTIn interest-based transactions, risk is transferred to the borrower so that all interest-bearing assets become risk free. (this is socially inequitable and economically inefficient)

In term value of money, the capital involved in trade may grow or decline though time, while in riba based transaction, capital automatically increases over time.

EVOLUTION OF FINANCIAL PRINCIPLES DURING THE PERIOD Many Muslim scholars held the view that the Islamic financing approach should primarily be based upon a principle whereby the rate of return on financial capital should vary in accordance with the variations in the return of the whole enterprise such as in:

Profit Sharing Principle (PSP)Profit and Loss Sharing Principles (PLSP)

SALE PROFIT SHARING PRINCIPLE (PSP)

PSP is base on the mudarabah principle i.e. profits will be shared between the owner of capital and the entrepreneur on the basis of a contractual agreement whereas losses under normal circumstances would be written on capital

PROFIT AND LOSS SHARING PRINCIPLES (PLSP) The PLSP is related to the musharakah principle. Profits are distributed according to contractually agreed shares, but the liability of loss is proportionate to the capital contribution

MURABAHAHMARK-UP PRINCIPLE Selling for the cost price plus a specified profit, provided that both the seller and the buyer know the cost price.

FORMS OF PERMISSIBLE DEFERRED SALES Salam sale (the price is paid at the time of contract but the object of sale becomes due as debt in kind).

Mauajjal sale ( the object of sale is delivered at the contract time but the price becomes due as debt)

Istisna sale ( the price is paid at the time of contract ad the object of sale is manufactured and delivered later)

CONT. FORMS OF PERMISSIBLE DEFERRED SALES Ijarah ( the sale of the use rights of assets where assets are delivered to the user, who in turn pays periodic rentals)

Murabahah li alamer bi al shira (sale with a known profit which may or may not create debt)

Musharakah Mutanaqisah is a form of partnership in which one of the partners promises to buy the equity share of the other partner gradually until the title of the equity is completely transferred to him

JUSTIFICATION OF MURABAHAHAS AN ALTERNATIVE TO RIBASome scholars are of the view that Murabahah is a mere replication of interest based loans and thus it is not itself a viable alternative to Riba.

Others scholars nullified this and provide evident to justify murababah as an alternative to riba and not similar to riba

BASIC CHARACTERISTICS AND REQUIREMENTS OF MURABAHAH Since Murabahah is a type of sale contract, three pillars of sale must be present

The two contracting parties, The offer and acceptance; and The subject matter of the sale

MURABAHAH IN THE BANKING Murabahah in the banking practices used when a client needs financing to buy some commodity or goods, the bank will buy the commodity and sells them to the client on the cost plus basis. Thus it is different from advancing a loan to the client based on interest.

CONDITIONS FOR SELLHowever for the validity of the Murabahah sell, three conditions has to be fulfilled;

The commodity must be in existence during the contractThe seller should have acquired the ownership of the commodity The commodity should have come into possession of the seller, either physically or constructively.

Q & A

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