Chapter 9-Islamic Banking

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CHAPTER 9

ISLAMIC BANKING


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INTRODUCTION The origin and basis of Islamic banking is

shariah, ie., Islamic laws and sometimes

referred to as Islamic Jurisprudence

Islam may be perceived as comprising threebasic elements, that are;

Aqidah

Concerns all forms of faith and belief by a Muslim in

Allah and His will, from the fundamental faith in His

being to the ordinary beliefs in His individual

commands

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CONT

ShariahConcerns all forms of practical actions by a

Muslim manifesting his faith and belief

Divided into:Ibadat

Concerned with the practicalities of

his worship to Allah, in the context of

man-to-Allah relationship

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CONTMuamalat

Concerned with the practicalities of hismundane daily life, in the context ofvarious forms of man-to-manrelationship

Muamalat conduct:

Muslims economic activities within hiseconomic system

Within the economic system, there isthe banking and financial systemwhere man conducts his banking andfinancial activities

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CONT

Akhlaq

Concerns behavior, attitude and work

ethics with which a Muslim performs his

practical actions

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ISLAM

AQIDAH SHARIAH AKHLAQ

(faith & belief) (Practices & Activities) (Moralities & Ethnics)

IBADAT MUAMALAT

(Man to God Worship) (Man to Man Activities)

POLITICAL ECONOMIC SOCIAL

ACTIVITIES ACTIVITIES ACTIVITIES

BANKING & FINANCIAL ACTIVITIES

ISLAM, SHARIAH, MUAMALAT, BANKING & FINANCE

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CONT

The primary sources of Shariah are:

Al-Quran

Al-Sunnah

Banking and financial activities are partand parcel of Islamic Muamalat, therefore

subject to the Shariah Laws on Muamalat

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THE OBJECTIVES OF ISLAMIC BANKS To promote, foster and develop the banking

services and product based on Islamic principles

Also responsible for promoting the

establishment of investment companies or otherbusiness enterprises as long as the activities of

these companies are not forbidden by Islam

The main principles of Islamic banking comprise

of prohibition of interest in all forms oftransactions, and undertaking business and

trade activities on the basis of fair and legitimate

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PROHIBITION OF RIBA (INTEREST)

The most important aspect of Islamic banking is

that its operations must be conducted without

any element ofriba

Ribatechnically refers to the premium that

must be paid by the borrower to the lender along

with the principle amount as a condition for the

loan or for an extension on its maturity

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PRINCIPLES OF SHARIAH IN ISLAMICBANKING The most widely used Shariah principles

recommended by Islamic scholars are:

Profit and loss sharing principles

Mudarabah

Musharakah

Fees or charges based principles

MurabahahBai mu azzal

Ijarah

Ijarah wa-iktina10


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CONT

Free service principle

Qard hassan

Ancillary principlesWadiah

Rahn

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MUDARABA Means profit-sharing or trust finance or

investment through self-employed entrepreneur

An agreement between at least 2 parties, one

being a lender or sometimes known as aninvestor and an entrepreneur also known as asagent-manager

In the agreement, the investor agrees to finance

or entrust money to the entrepreneur who is totrade in an agreed manner and then return tothe investor the principal and pre-agreedproportion of profits and keep for himself the

remainder 12


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CONT

The distribution of profits between the 2 parties

must be on a proportional basis and cannot be a

lump sum or a guaranteed amount

In the case of loss (as a result of circumstances

beyond the control of entrepreneur), the investor

will bear all financial risks and the entrepreneur

loses the time and his efforts only

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MUSHARAKAHPartnership or participating financingAlso means a joint venture agreement between

2 parties to engage in a specific business activitywith an aim of making profit

The termination of the agreement may be basedon time or after fulfillment of certain conditions

Under this concept, both parties will have to

provide capital to the business, and the investoror lender may also participate in themanagement of the business or company

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MURABAHAH Cost-plus financing or financing resale of

goods

Refers basically to the sale of goods at a price

covering the purchase price plus a profit marginagreed upon by both parties concerned

This arrangement transforms a traditionallending activity into a sale and purchase

agreement Lender buy goods that the borrower need, and

then sale it to the borrower at a higher price,agreed by both parties

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BAI MUAZZAL

Is a variant concept of murabahah

Under this principle, the borrower is allowed to

defer settlement of payment for goods purchased

within the period, and in a manner determined andagreed by both parties

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IJARAH WA-IKTINA

Refers to a contract whereby a bank will

purchase an asset, and then rent the asset to

the customer on an agreed rental, together

with the clients agreement to makepayments which will eventually lead to the

transfer of ownership from bank to customer

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QARD HASSAN

S benevolent loan that obliges a borrower to

repay the lender the principal sum borrowed

on maturity of the loan

The borrower, however has the discretion to

reward the lender for his loan by paying any

sum over and above the amount of the

principal

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WADIAH

Refers to an agreement between the owner

of assets and another party, whereby the

owner will deposit and give consent to the

custodian to make use of their assets (funds)as long as these assets remain in the

custodians hands

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RAHN

A contract of pledging a security and

becomes binding when possession of the

pledge has taken place In this principle, the ownership of the

security is not transferred to the pledgor

The pledgor will keep the security for acertain period agreed by both parties

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CONT

Upon maturity, the owner of the assets will

have to pay back the pledgors money and

he will get back his assets

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PRINCIPLE OF SHARIAH

Muslim scholars agreed that the principles

adopted by the Islamic banks belong to 2

categories:

Strongly Islamic

Weakly Islamic

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Only those principles which permit risk-returnsharing between providers and users offunds can be considered strongly Islamic

Muslim scholars consider only 2 principles asstrongly Islamic

Mudarabah

Musharakah

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Chapter 9-Islamic Banking

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