Page | 67

ISLAMIC FINANCE – AN OVERVIEW

The foregoing chapter reviewed the pertinent and published literature on Islamic banking,

finance and economy and concluded that although substantial literature work has been

done in the area, yet this aspect of compatibility of Islamic finance and its objectives and

achievements remained outside the focus of scholars so far. To bridge this gap, the

present study is undertaken whose objectives have been set out and hypotheses

formulated. The present chapter is devoted to present an overview of the Islamic finance

and discusses its theoretical background, operation and growth in countries pursuing it

and the challenges ahead.

3.1. Background

Islam stands for peace - peace for all, not for Muslims alone. In fact, Islam when defined

incorporates in its fold safety and security for the whole mankind. Holy Quran, the divine

scripture addresses all human beings, not only the Muslims. Prophet of Islam, Hadrat

Muhammad (peace be upon him) is known as the benefactor of mankind. Thus, Islam’s

massage is for the whole universe and Allah (God) is the lord of all the worlds. It is

universal in its nature, essence, belief, philosophy, ideology, approach and practice

(Ahmad, 2008). Islam is a complete religion6, which means all aspects of life like

relation of human being with its creator, mankind and the world affairs have been

explained in the Qur’an7 and Sunnah

8. Islam by its real meaning denotes the phenomenon

6 (Qur’an 5:3). ‘5’ indicates the chapter number and ‘3’ indicates the verse number. 7Qur’an is the highest and most authentic authority in Islam. It consists the sacred writings of Islam

revealed by Allah (God) to the prophet Muhammad (PBUH) during his life at Mecca and Medina.

Quotations from the Quran are normally followed by a reference to the number of the chapter (sura) and the

number of the quoted verse (aya). All Quranic texts in this thesis are printed in Italic.

Page | 68

of completely following the command of somebody. In general understanding, it is the

state in which somebody follows the instructions of Allah (God). Islam by its very nature

is not a religion like any other religion. It is a “Deen” which denotes a complete way of

living and provides with a complete set of instructions to be followed in the whole life of

Muslim. These include the “Ibadaat” and “Muamlaat” i.e. the modes of worship in

different styles and the matters of dealing with others. The teachings of Islam

encompasses the essence of economic well-being and the development of Muslims at the

individual, family, society, state and ummah (or Islamic universal community) levels. In

order to appreciate the Islamic concepts of banking and finance, it is essential to place

them within the context of beliefs and philosophy underlying Islam. Figure 3.1 illustrates

the Islamic view of life and the position of banking and financial activities within that

overall framework.

8 It is a collection of the Prophet’s sayings and deeds, including his opinions about matters, as well as the

practices of his companions. The sunnah occupies a place second to the Qur’an.

Page | 69

Figure 3.1: The Islamic View of Life

(Sources: Brian Kettell, Islamic Banking in the Kingdom of Bahrain (BMA, 2002))

Islam

Aqidah (faith and Belief)

Sharia’h (Practices & Activities)

Akhlaq (Moralities & Ethics)

Muamalat (Man-to-man activities)

Ibadah (Man-to-God worship)

Social Activities

Economic Activities

Political activities

Banking and Financial Activities

Other Economic Activities

Banking

Equity & Capital

Market

Takaful

Waqf & Zakat

Page | 70

3.2. Sources of Islamic/Divine Law

Islamic law has following sources. Any product issued by Islamic banks and financial

institutions are screened through the proper process by Shariah Advisors9. So any product

which Islamic Banks and Financial Institutions (IBFIs) issue is put under a microscope to

explore whether the same is following the Shariah or not. Following are the methods for

doing the same.

3.2.1. The Qur’an: is the first and most important source of Islamic law. Believed to be

the direct word of Allah (God) as revealed to Prophet Muhammad (PBUH10

) through

angel Gabriel in Mecca and Medina, the scripture specifies the moral, philosophical,

social, political and economic basis on which a society should be constructed. The verses

revealed in Mecca deal with philosophical and theological issues, whereas those revealed

in Medina are concerned with socio-economic laws. The Qur'an was written and

preserved during the life of Muhammad, and compiled soon after his death (Nomani &

Rahnema, 1994).

3.2.2. The Sunnah: is the next important source, and is commonly defined as ‘the

traditions and customs of Muhammad’ or ‘the words, actions and silent assertions of

him’. It includes the everyday sayings and utterances of Prophet Muhammad (PBUH), his

acts, his tacit consent, and acknowledgments of statements and activities. In simple

words, Sunnah is the combination of sayings, acts and tacit approval of Prophet

Mohammad (PBUH).

3.2.3. Ijma (consensus): is considered the third fundamental source of Islamic law. The

ijma is the consensus of the opinions of the learned men and the jurists. In simple words,

Ijma is the consensus of the Ulama based on the Book of Allah, the instructions of the

Prophet and his actions, demonstrations and preaching as well as speeches.

9 a committee of religious advisers whose opinion is sought on the acceptability of new instruments, and

which conduct a religious audit of the bank’s activities as well as other features reflecting their religious

status. These are usually those people who have a command on economic as well as religious knowledge. 10 Peace Be Upon Him (PBUH)

Page | 71

3.2.4. Qiyas (analogy): is the process of deductive analogy in which the teachings of the

Hadith are compared and contrasted with those of the Qur'an, in order to apply a known

injunction (nass) to a new circumstance and create a new injunction. Here the ruling of

the Sunnah and the Qur'an may be used as a means to solve or provide a response to a

new problem that may arise. It is the fourth source of Islamic law.

3.2.5. Ijtehaad: is the use of human reason to arrive at an elaboration or exploration of

the Shari’a Law. It starts with the principles of the Qur’an, Sunnah, or Ijma and cannot be

used to achieve that which contradicts a rule established therein.

All products and services are put in a microscope by shariah Advisors to explore whether

any product goes against the teachings of Islamic law and the same is then dropped from

the list of approved products.

3.3. Interest

In modern secular economic systems, interest plays a very important role. In fact, in the

Western World people cannot think of any economic system without interest. From a

theoretical standpoint, interest has been a debatable subject among economic and political

theorists. Abu Saud (1983) defines interest as “the excess of money paid by the borrower

to the lender over and above the principal for the use of the lender’s liquid money over a

certain period of time”. Economists have presented different interpretations of interest.

Samuelson (1976) states that Interest is the price of rental for the use of money. (Patinkin,

1972) defines it as “Interest is one of the forms of income from property, the other forms

being dividends, rent and profit”. However, (Keynes, 1936) did not define interest but

mentioned the rate of interest as “the percentage of excess of a sum of units of money

contracted for forward units of time over the spot or cash price of the sum thus contracted

for forward delivery”.

Page | 72

However, Muslim, socialist and a number of capitalist economists have questioned these

explanations on both theoretical and technical grounds. They often stress the point that

money cannot be treated as capital goods on the same basis as productive factors. It is

pertinent to remark here that lending of money for interest was abhorred and, in most

cases, prohibited by all the monotheistic religions (Al-Harran, 1993). An eminent

Western economist, (Harrod, 1973), regards the abolition of interest is the only way to

avert a collapse of capitalism. Not only this, but he speaks with great admiration for an

interest-less society in his work on Economic Dynamics. Harrod clearly recognizes that,

“It is not the profit itself, earned by services, by assiduity, by imagination, or by courage,

but the continued interest accruing from the accumulation that makes that profit taker

eventually appear parasitical…” and he further states that an interest-less society which

will be a totally new kind of society” would be the correct and final answer to all that is

justly advanced by the critics of capitalism.

3.4. The Prohibition of Riba (Interest)

In Islam, interest in prohibited in both Quran and Sunnah.

3.4.1. The prohibition of Riba in the Qur’an

First stage (Surah al-Rum, verse 39): That which you give as interest to increase the

people’s wealth increases not with God; but that which you give in charity, seeking the

goodwill of God, multiplies manifold. (30:39)

Second Stage (Surah al-Nisa, verse 161): And for their taking interest even though it

was forbidden for them, and their wrongful appropriation of other peoples’ property, We

have prepared for those among them who reject faith a grievous punishment. (4: 161)

Third Stage (Surah Al-Imran, verse 130-2): O believers, take not doubled and

redoubled interest, and fear God so that you may prosper. Fear the fire which has been

Page | 73

prepared for those who reject faith, and obey God and the Prophet so that you may

receive mercy. (3: 130-2)

Fourth stage (Surah al-Baqarah, verses 275-281): 275. Those who benefit from

interest shall be raised like those who have been driven to madness by the touch of the

Devil; this is because they say: "Trade is like interest" while God has permitted trade and

forbidden interest. Hence those who have received the admonition from their Lord and

desist, may have what has already passed, their case being entrusted to God; but those

who revert shall be the inhabitants of the fire and abide therein forever.

God deprives interest of all blessing but blesses charity; He loves not the ungrateful

sinner. (2:276)

Those who believe, perform good deeds, establish prayer and pay the zakat, their reward

is with their Lord; neither should they have any fear, nor shall they grieve. (2:277)

O believers, fear God, and give up the interest that remains outstanding if you are

believers. (2:278)

If you do not do so, then be sure of being at war with God and His Messenger. But, if you

repent, you can have your principal. Neither should you commit injustice nor should you

be subjected to it. (2:279)

If the debtor is in difficulty, let him have respite until it is easier, but if you forego out of

charity, it is better for you if you realize.(2:280)

And fear the Day when you shall be returned to the Lord and every soul shall be paid in

full what it has earned and no one shall be wronged. (2: 281)

Page | 74

3.4.2. Prohibition of Riba in Hadith

1. From Jabir: The Prophet, may peace be on him, cursed the receiver and the payer of

interest, the one who records the transaction and the two witnesses to the transaction and

said: "They are all alike (in guilt)11

”

2. Jabir ibn Abdallah, giving a report on the Prophet’s Farewell Pilgrimage, said: The

Prophet, peace and blessings of God be on him, addressed the people and said: All of the

riba of Jahilliyyah is annulled. The first riba that I annul is our riba, that accruing to

Abbas ibn Abd al-Muttalib (the Prophet's uncle); it is being cancelled completely12

.

3. From Abdallah ibn Hanzalah: The Prophet (peace be on him) said: "A dirham of riba

which a man receives knowingly is worse than committing adultery thirty-six times13

"

4. From Abu Hurayrah: The Prophet (peace be on him) said: "On the night of Ascension I

came upon people whose stomachs were like houses with snakes visible from the outside.

I asked Gabriel who they were. He replied that they were people who had received

interest”14

.

5. From Abu Hurayrah: The Prophet (peace be on him) said: "There will certainly come

a time for mankind when everyone will take riba and if he does not do so, its dust will

reach him”15

.

7. From Abu Hurayrah: The Prophet (peace be on him) said: "God would be justified in

not allowing four persons to enter paradise or to taste its blessings: he who drinks

habitually, he who takes riba, he who eats an orphan's property without right, and he who

is undutiful to his parents"16

.

11Muslim, Kitab al-Musaqat, Bab la'ana akil al-riba wa mu’kilahu; also in Tirmidhi and Musnad Ahmad. 12Muslim, Kitab al-Hajj, Bab Hajjat al-Nabi, may peace be on him; also in Musnad Ahmad. 13Mishkat al-Masabih, Kitab al-Buyu, Bab al-riba, on the authority of Ahmad and Daraqutni). Bayhaqi has

also reported the above hadith in Shuab al-Iman with the addition that "Hell befits him whose flesh has

been nourished by the unlawful" (ibid.) 14Ibn Majah, Kitab al-Tijarah, Bab al-taghliz fi al-riba; also in Musnad Ahmad. 15Abu Dawud, Kitab al-Buyu, Bab fi ijtinab alshubhat; also in Ibn Majah. 16Mustadrak al-Hakim, Kitab al-Buyu.

Page | 75

3.5. The meaning of Riba (Usury)

After knowing these severe verdicts of the Qur’an and the Sunnah against riba, it is

necessary to determine what the term riba really stands for. Riba literally means increase,

addition, expansion or growth. It is, however, not every increase or growth which has

been prohibited by Islam (Chapra, 2006). In the Shari’ah, riba technically refers to the

"premium" that must be paid by the borrower to the lender along with the principal

amount as a condition for the loan or for an extension in its maturity. In this sense, riba

has the same meaning and import as interest in accordance with the consensus of all the

fuqaha without any exception.

3.6. Types of Riba

The term riba is, however, used in the Shari‘ah in two senses. The first is riba al-nasi’ah

and the second is riba al-fadl.

3.6.1. Riba al-Nasi’ah

The term nasi’ah comes from the root ‘nasa’a’ which means to postpone, defer, or wait,

and refers to the time that is allowed to the borrower to repay the loan in return for the

‘addition’ or the ‘premium’. Hence riba al-nasi’ah is equivalent to the interest charged

on loans. It is in this sense that the term riba has been used in the Qur’an in verse 2:275,

which states that “God has allowed trade and forbidden riba (interest)”

The prohibition of riba al-nasi’ah essentially implies that the fixing in advance of a

positive rate of return on a loan as a reward for waiting is not permitted by the Shari‘ah.

It makes no difference whether the rate of return is small or big, or a fixed or variable per

cent of the principal, or an absolute amount to be paid in advance or on maturity, or a gift

or service to be received as a condition for the loan. The point in question is the

predetermined positiveness of the return. It is important to note that, according to the

Page | 76

Shari‘ah, the waiting involved in the repayment of a loan does not by itself justify a

positive reward.

There is hardly any room even for arguing that the prohibition applies only to

consumption loans and not to business loans. This is because the borrowing during the

Prophets’ times was not for consumption purposes but rather mainly for financing long

distance trade. Accordingly, the late Shaykh Abu Zahrah, one of the most prominent and

respected Islamic scholars of this century, has rightly pointed out that: ‘There is

absolutely no evidence to support that the riba of al-Jahiliyyah (pre-Islamic days) was on

consumption and not on development loans. In fact the loans for which a research scholar

finds support in history are production loans. The circumstances of the Arabs, the

position of Makkah and the trade of Quraysh, all lend support to the assertion that the

loans were for production and not consumption purposes’ (Abu-Zahrah, 1970). Even

Professor Abraham Udovitch, Ex-Chairman of the Department of Near Eastern Studies at

the Princeton University, has clarified that ‘Any assertion that medieval credit was for

consumption only and not for production, is just untenable with reference to the medieval

Near East’( Udovitch, 1970). Hence, the Quranic verse about remitting the principal in

the event of the borrower’s hardship does not refer to consumption loans. It refers

essentially to interest-based business loans where the borrower had encountered losses

and was unable to repay even the principal, leave alone the interest.

The whole argument that interest causes hardship only for the one who borrows for

consumption needs is misfounded. It is the obligation of the Muslim society to meet the

dire consumption needs of the poor. Borrowing for conspicuous consumption has been

discouraged by Islam and most of the borrowing in the classical Muslim society was for

business purposes.

It is only in this context that one may be able to understand the argument of the

Jahiliyyah that trade is like interest and the distinction that the Qur’an draws between

trade and interest. While in trade an entrepreneur has the prospect of making a profit, he

also faces the risk of incurring a loss. In contrast with this, interest is predetermined to be

Page | 77

positive irrespective of the ultimate outcome of business, which may be positive or

negative depending to a great extent on factors beyond the control of the entrepreneur.

Imam Razi (d. 313AH/925AC) himself posed the question of what was wrong in

charging interest when the borrower was going to employ the funds so borrowed in his

business and thereby earn a profit. His well-considered reply to the question was: ‘While

the earning of profit is uncertain, the payment of interest is predetermined and certain.

The profit may or may not be realized. Hence there can be no doubt that the payment of

something definite in return for something uncertain inflicts harm17

. Accordingly, riba is

essentially in conflict with the clear and unequivocal Islamic emphasis on socio-

economic justice. Financiers who do not wish to take the risk are entitled to only the

principal and no more. Those who insist on charging riba in spite of its prohibition are

declared by the Qur’an to be at war with God and His Prophet (PBUH).

On the occasion of his Farewell Pilgrimage, the Prophet (PBUH) while declaring the

abolition of interest announced the remission of interest accumulated in favour of his

uncle Abbas ibn Abd al-Muttalib18

. This was interest on business loans extended to the

Banu Thaqif tribe. This tribe had not taken the loan from Abbas and others for fulfilling

consumption needs but for expanding their business (Abu-Zahrah, 1970). This was not an

isolated case but a prevalent form of business financing in those days. Several tribe

members having skill in trading acted essentially like large partnerships, borrowing

finance from members of their own tribe or from other friendly tribes, to carry long-

distance trade on a large scale, which their own resources would not permit. This is

because they could not undertake too many business trips abroad from east to west. The

slow means of communication, the difficult terrain and the harsh climate confined them

to mainly two caravan trips during the year, one in summer and one in winter19

.

Accordingly they collected all the finance they could muster to purchase the exportable

17 Commentary on verse 2:275 in Tafsir al-Kabir of Fakhruddin al-Razi. 18 Jabir ibn Abdallah, giving a report on the Prophet's Farewell Pilgrimage, said: The Prophet, peace and

blessings of God be on him, addressed the people and said: All of the riba of Jahilliyyah is annulled. The

first riba that I annul is our riba, that accruing to Abbas ibn Abd al-Muttalib (the Prophet's uncle); it is

being cancelled completely. (Muslim, Kitab al-Hajj, Bab Hajjat al-Nabi, may peace be on him; also in

Musnad Ahmad). 19 (al-Qur’an, 106:2)

Page | 78

local produce, sell it abroad and bring back what was necessary to satisfy the entire needs

of their society for imports during a specific period. Most of the interest-based

transactions mentioned in the classical commentaries in relation to the prohibition of riba

are loans taken by tribes from each other, each tribe acting like a large partnership

company. Islam abolished the interest-based nature of these relationships and reorganized

them on a profit-and-loss sharing basis. The financier got a just share and the

entrepreneur did not get crushed under adverse conditions, one of which was the caravan

being way-laid on the way. There is, thus, absolutely no difference of opinion among all

schools of Muslim jurisprudence that riba al-nasi’ah stands for interest and, is haram or

prohibited20

. The nature of the prohibition is strict, absolute and unambiguous. However,

if the return on principal can be either positive or negative, depending on the final

outcome of the business, which is not known in advance, it is allowed provided that it is

shared in accordance with the principles of justice laid down in the Shari‘ah.

3.6.2. Riba al-Fadl

While Islam has prohibited interest on loans and allowed trade; it has not allowed

everything in trade. This is because it wishes to not merely eliminate the injustice that is

intrinsic in the institution of interest on loans as well as all forms of dishonest and unjust

exchanges in business transactions, but also close the backdoor to riba because,

according to the unanimously accepted legal maxims of Islamic jurisprudence, anything

that serves as a means to the unlawful is also unlawful. Since people may be exploited or

cheated in several different ways, the Prophet warned that a Muslim could indulge in riba

in seventy (several) different ways21

. This is the reason why the Prophet, peace and

blessings of God be on him, said: “Leave what creates doubt in your mind in favour of

what does not create doubt”22

. Caliph Umar was thus inspired to say: “Abstain not only

20 Abd al-Rahman al-Jaziri's book ‘Al-Fiqh Ala al-Madhahib al-Arba‘ah’, is a compendium on the juristic

opinions of the four predominant schools of Muslim jurisprudence. It is held in high esteem and considered

to be an authority on the subject. 21 From Abu Hurayrah: The Prophet, peace be on him, said: "Riba has seventy segments, the least serious

being equivalent to a man committing adultery with his own mother” (Ibn Majah) 22 Cited by Ibn Kathir in his commentary on verse 2:275.

Page | 79

from riba but also from ribah”23

. Ribah is from rayb which literally means ‘doubt’ or

‘suspicion’ and refers to income which has the semblance of riba or which raises doubts

in the mind about its rightfulness. It covers all income derived from injustice to, or

exploitation of, others. Thus, it may be said in brief that anything that is unjustifiably

received as ‘extra’ by one of the two counterparties to a trade transaction is riba al-fadl,

which may be defined in the words of Ibn al-Arabi as “all excess over what is justified by

the counter-value”(Ibn-Arabi, 1957).

The Prophet, peace and blessings of God be on him, has indicated, by way of example, at

least four different ways of indulging in riba al-fadl. These are not all-inclusive but,

nevertheless, help us understand the implications of riba al-fadl. The first of these is the

exploitation that may take place in trade through the use of unfair means even though

trade is by itself allowed. He equated with riba even the cheating of an unsophisticated

entrant into the market (ghabn al-mustarsil) and the rigging of prices in an auction with

the help of an agent24

. Analogically one may conclude that the extra money earned

through such exploitation and deception falls within the ambit of riba al-fadl. Another

way of being guilty of indulging in riba al-fadl is by accepting a reward in return for

making a recommendation in favour of a person25

. This implies that the performance of

an apparently charitable act with the intention of making money surreptitiously is also

prohibited. The rationale behind this may be that such a money-motivated

recommendation might give benefit to a person who does not deserve and, thereby,

indirectly deprive others who are more deserving.

23 From Umar ibn al-Khattab: The last verse to be revealed was on riba and the Prophet, peace be on him,

was taken without elaborating it to us; so give up not only riba but also ribah [whatever raises doubts in the

mind about its rightfulness] (Ibn Majah, op. cit.,). 24There are two Hadiths related to this:

(1):From Anas ibn Malik: The Prophet, peace be on him, said: "Deceiving a mustarsal [an unknowing

entrant into the market] is riba (Suyuti, al-Jami al-Saghir, under the word ghabn; Kanz al Ummal, Kitab al-

Buyu, al-Bab al-thani, al-fasl al-thani, on the authority of Sunan al-Bayhaqi)

(2): From Abdallah ibn Abi Awfa: The Prophet, peace be on him, said: "A najish (one who serves as an

agent to bid up the price in an auction) is a cursed taker of riba (Cited by Ibn Hajar al-Asqalani in his

commentary on al-Bukhari called Fath al-Bari, Kitab al-Buyu, Bab al-najash; also in Suyuti, al-Jami al-

Saghir, under the word alnajish and Kanz al-Ummal, op. cit., both on the authority of Tabarani's al-Kabir). 25From Abu Umamah: The Prophet, peace be on him, said: "Whoever makes a recommendation for his

brother and accepts a gift offered by him has entered riba through one of its large gates" (Bulugh al-Maram,

Kitab al-Buyu, Bab al-riba, reported on the authority of Ahmad and Abu Dawud).

Page | 80

A third way of indulging in riba al-fadl is through barter transactions because of the

difficulty of measuring the counter-values precisely in such transactions. The Prophet,

peace and blessings of God be on him, therefore discouraged barter in a monetized

economy and required that the commodity to be exchanged on the basis of barter be sold

against cash and the proceedings used to buy the needed commodity26

. This leads to the

fourth way of indulging in riba al-fadl which has received the maximum attention of the

fuqaha. A number of authentic hadiths stipulate that, if the same genus of commodities is

exchanged against each other, then the same quantity and weight of the commodities

(sawa’an bi sawa’in and mithlan bi mithlin or equal for equal and like for like) should be

exchanged hand-to-hand (yadan bi yadin)27

. If the commodities exchanged are different,

it does not matter if there is difference in weight and quantity, provided that the exchange

takes place hand to hand. One of the implications of this requirement is the elimination of

the backdoor to riba (which is referred to in fiqh as sadd al-dhari‘ah). Another

implication of these hadiths, as understood by the fuqaha, is the prohibition of futures

26This is explained in three hadiths:

(1): From Abu Sa‘id and Abu Hurayrah: A man employed by the Prophet, peace be on him, in Khaybar

brought for him janibs [dates of very fine quality]. Upon the Prophet's asking him whether all the dates of

Khaybar were such, the man replied that this was not the case and added that they exchanged a sa’ [a

measure] of this kind for two or three [of the other kind]". The Prophet, peace be on him, replied, "Do not

do so. Sell [the lower quality dates] for dirhams and then use the dirhams to buy janibs." [When dates are

exchanged against dates] they should be equal in weight". (Bukhari, Kitab al-Buyu, Bab idha arada bay

tamarin bi tamarin khayrin minhu; also Muslim and Nasa’i).

(2): From Abu Sa’id: Bilal brought to the Prophet, peace be on him, some barni [good quality] dates

whereupon the Prophet asked him where these were from. Bilal replied, "I had some inferior dates which I

exchanged for these - two sa’s for a sa’." The Prophet said, "Oh no, this is exactly riba. Do not do so, but

when you wish to buy, sell the inferior dates against something [cash] and then buy the better dates with the

price you receive". (Muslim, Kitab al-Musaqat, Bab al-ta‘am mithlan bi mithlin; also Musnad Ahmad).

(3): From Fadalah bin Ubayd al-Ansari: On the day of Khaybar he bought a necklace of gold and pearls for

twelve dinars. On separating the two, he found that the gold itself was equal to more than twelve dinars. So

he mentioned this to the Prophet, peace be on him, who replied, "It [jewellery] must not be sold until the

contents have been valued separately". (Muslim, Kitab al-Musaqat, Bab bay al-qiladah fiha kharaz wa

dhahab; also in Tirmidhi and Nasa’i). 27This is explained in two Hadiths:

(1): From Abu Sa‘id al-Khudri: The Prophet, peace be on him, said: "Do not sell gold for gold except when

it is like for like, and do not increase one over the other; do not sell silver for silver except when it is like

for like, and do not increase one over the other; and do not sell what is away [from among these] for what is

ready". (Bukhari, Kitab al-Buyu, Bab bay al-fiddah bi al-fiddah; also Muslim, Tirmidhi, Nasa’i and

Musnad Ahmad).

(2): From Abu Sa’id al-Khudri: The Prophet, peace be on him, said: "Gold for gold, silver for silver, wheat

for wheat, barley for barley, dates for dates, and salt for salt - like for like, and hand-to-hand. Whoever pays

more or takes more has indulged in riba. The taker and the giver are alike [in guilt]". (Muslim, ibid; and

Musnad Ahmad).

Page | 81

transactions in foreign exchange. This is because, if the rate of exchange is fixed in

advance for a futures exchange in currencies, there may be a great deal of injustice if the

market rate of exchange changes. The Shari‘ah, therefore, requires that in a futures

transaction the exchange must take place on the basis of the rate prevailing on the date of

settlement. However, whether hedging, which is one way of managing the risks involved

in exchange rate fluctuations, is possible within the constraints of the Shari‘ah is a

question which needs the attention of the fuqaha.

3.7. Historical development of Islamic Finance

A few pilot experiences preceded the formal start of Islamic banking were done

throughout the world especially in Muslim countries. In the Indian subcontinent, loan

cooperatives, influenced by European mutual loan experiments (Mortimer, 1982) and

infused with religious and ethical ideals, were started from the 1940s (Heikal, 1983). At

least one (short-lived) experiment took place in Pakistan in the late 1950s, when rural

landlords created an interest free credit network (Richards, 1993)

. In Malaysia, the Muslim

Pilgrims Savings Corporation was set up in 1963 to help people save for performing their

religious pilgrimage (haj). It later evolved into the Pilgrims Management and Fund

Board, or the Tabung Haji as it is now popularly known – an Islamic savings bank of

sorts which invested the savings of prospective pilgrims in accordance with the Shariah

(Henry, 1996).

The highest profile experiment was conducted in Egypt between 1963 and 1967, in Mit

Ghamr in the Nile Delta. The founder, Dr Ahmed al-Najjar (who would later become

Secretary of the IAIB [International Association of Islamic Banks]), had been educated in

West Germany and greatly influenced by the mutual savings schemes, he discovered

there. With capital supplied by West German banks, he obtained the support of the

Egyptian government. At its peak, the bank had nine branches in operation, 250,000

depositors and close to two million Egyptian pounds in deposits. Although its charter

Page | 82

made no reference to Islam or the Shariah, the bank neither paid nor charged interest. It

earned profits by engaging in trade and industry directly or in partnership with others,

and to a lesser extent by financing business on a profit-sharing basis (Karawan, 1992).

The circumstances of its closure are somewhat obscure. By certain accounts the bank had

encountered severe financial problems. Others suggest that the bank was commercially

successful but was closed for political reasons, which ranged from fear of Islamic

fundamentalism to disagreements over how the bank should be regulated (Galloux,

1997). In 1971, as part of its policy of coopting Islamic groups in its fight against leftist

elements, the Egyptian government created the Nasser Social Bank. The official goals

were to ‘broaden the base of social solidarity among citizens’ and ‘provide aid to needy

citizens’. As with the previous experiment, there was no direct reference to religion, but

the bank’s operations were based on mudaraba (profit-and-loss sharing) and the

collection and distribution of zakat (almsgiving).

Estimates vary of the size and growth rates of assets held internationally under Islamic

finance, but suggest that Islamic finance is a rapidly growing industry. While it represents

a small proportion of the global finance market (estimated at 1%-5% of global share), the

Islamic finance industry has experienced double-digit rates of growth annually in recent

years (estimated at 10%- 20% annual growth)28

. Industry experts estimate that assets held

under Islamic finance management doubled between 2007 and 2010 to reach around $1

trillion29

. A survey of the top 500 Islamic financial institutions shows that shariah-

compliant assets in these institutions rose from $822 billion in 2009 to $895 billion in

2010. In 2010, 18 new banks offering SCF entered the market and six conventional banks

started providing SCF via “Islamic finance windows30

”.

The list of Islamic banks and financial institutions in the world has been put in tabular

form in annexure – II.

28

David Oakley, Shannon Bond, Cynthia O’Murchu, and Celve Jones, “Islamic Finance Explained,” Financial Times,

May 30, 2008. Jennifer Jacobs, "Special Focus: Islamic Finance Gains Ground," The Edge Malaysia, October 25,

2010. 29 Reuters, "Islamic Finance Set to Cross $1 Trillion: Moody's," The Economic Times, October 21, 2010. 30 Jospeh DiVanna and Brian Caplen, "Top 500 Islamic Financial Institutions," The Banker, November 2, 2010.

Page | 83

Islamic finance is growing through out the world at an increasing rate. Different countires

in the world espacially muslim countries are trying to develop their economic systems

according to islamic principles. Iran, Pakistan, Saudi Arabia, Malaysia, Bahrain etc are

leading countries in the process of shifting their economic system from conventional to

islamic. As per one more estimate, till end-2009, global assets of islamic finance have

reached to $ 1, 041bn31

. Following is given the graphical representation of global assets

of islamic finance, till end-2009.

Chart 3.2 exhibits a steady growth in the global assets of Islamic finance 2006 through

209. Over this period, the increase in global assets has been around two fold. This

phenomenal growth in global assets of Islamic finance testifies its success and wide

acceptability.

The share of different types of assets which make up the global islamic funds and

managed by the islamic banking and other financial institutions are depicted in chart 3.3.

31 www.thecityuk.com and retrieved on June 13, 2011.

Page | 84

Equity funds account for the largest segment at 35% of funds, followed by alternative

investments and feeder funds accounting for 16%, fixed income and money market

sharing 14 % each. Other funds viz. commodities, real estate and the rest make up a small

portion at 12%, 7% and 2% respectively in the overall assets managed by Islamic funds.

The chart indicates that the equity funds stick out most prominently as the preferred

financial asset with Islamic financial institutions worldwide.

Page | 85

The table below (3.4) represents the banking, takaful and other assets of Islamic finance

till end-2009.

Table 3.4: Islamic finance by country*

Banking, Takaful, fund & other assets, $bn, 2009

Total Banks Takaful funds Others No. of firms

Iran 314.9 310.92 3.67 0.31 --- 22 S.Arabia 138.2 136.01 2.2 --- 0.03 25 Malaysia 102.6 96.69 3.8 --- 2.15 39 UAE 85.6 84.18 1.4 0.03 0.01 22 Kuwait 69.1 56.32 0.14 12.63 --- 37 Bahrain 44.9 42.71 0.42 1.73 --- 34 Qatar 34.7 32.4 0.4 1.87 0.01 18 Turkey 22.6 22.56 --- --- --- 4 UK 19.0 18.95 --- --- --- 22 Bangladesh 9.4 9.17 0.15 0.05 --- 16 Sudan 9.3 9.06 0.2 --- --- --- Egypt 7.2 7.21 0.01 --- --- 3 Indonesia 7.2 6.84 0.38 --- --- 26 Pakistan 6.2 6.2 --- --- --- 23 Syria 5.5 5.53 --- --- --- 3 Jordan 5.0 4.8 0.08 0.16 --- 10 Brunei 3.3 3.31 --- --- --- 6 Other countries 10.3 9.46 0.49 0.06 0.3 38 Total 895.0 862.32 13.34 16.84 2.5 348

*Includes only those firms submitting data to the Banker's survey Source: The Banker

Table 3.4 depicts the break-up of global Islamic finance by country. The allocation of

assets to individual countries from The Banker’s survey of 500 organizations reveal that

the leading countries for shariah compliant assets are Iran with $315bn, Saudi Arabia

$138bn and Malaysia $103bn (Table 3.4). These are followed by other Gulf States

including UAE, Kuwait, Bahrain, Qatar and then Turkey. The UK, in ninth place, is the

leading Western country with $19bn of reported assets, largely based on HSBC Amanah.

Countries with most of the 348 firms reporting to The Banker’s survey include Malaysia

Page | 86

with 39, Kuwait 37 and Bahrain 34. Indonesia, Saudi Arabia, Pakistan, Iran, UAE and the

UK each have between 20 and 26 firms supplying Islamic finance (Table 3.4).

Key centers are concentrated in Malaysia and the Middle East including Iran, Saudi

Arabia, Malaysia, Kuwait, UAE and Bahrain. These countries provide fertile ground for

future growth, although prospects for the Islamic finance in some Middle Eastern

countries could be affected by the spread of political upheaval in the region. Islamic

finance is also developing in Asian countries such as Bangladesh, Pakistan, India and

Indonesia, as well as North African countries such as Sudan and Egypt.

From the above graph, it is clear that Iran is the leading country in the world as far as

development of Islamic finance is concerned, which is followed by Saudi Arabia and

Malaysia. Malaysia is now becoming the leading Islamic finance country in the world

and it is expected that in future Malaysia may be a number one country in Islamic finance

industry development.

Page | 87

The list of Islamic banks and financial institutions in world has been put in tabular form

in annexure - II.

As data collection centers were Malaysia and United Arab Emirates, it is therefore

necessary to know the Islamic finance history and other related information of these two

countries.

3.8. Islamic Finance in Malaysia

In Malaysia, the roots of Islamic banking go back to 1963 when the government

established Tabung Haji or Pilgrims Management and Fund Board. The institution was

established to invest the savings of the local Muslims in interest free places, who intend

to perform pilgrim (Hajj). Tabung Haji utilizes Mudarabah32

(profit and loss sharing),

Musharikah33

(joint venture) and Ijara34

(leasing) modes of financing for investment

under the guidance of National Fatawah Committee of Malaysia.

The first call for separate Islamic bank was made in 1980, in a seminar held in the

National University of Malaysia. The participants passed a resolution requesting the

government to pass a special law to setup an Islamic bank in the country. Responding to

the request, the government set up a National Screening Committee in 1981 to study

legal, religious and operational aspects of setting up an Islamic bank. The committee

32 A form of partnership where one party provides the funds while the other provides expertise and

management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two

parties in pre-agreed ratios, while loss is borne by the provider of the capital. 33 Musharikah means a relationship established under a contract by the mutual consent of the parties for

sharing of profits and losses in the joint businesses. It is an agreement under which the Islamic bank

provides funds, which are mixed with the funds of the business enterprises and others. All providers of

capital are entitled to participate in the management, but not necessarily required to do so. The profit is

distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in

proportion to respective capital contributed. 34 A contract under which an Islamic bank finances equipment, building or other facilities for the client

against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the

lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise

does not become an integral part of the lease contract to make it conditional. The rental as well as the

purchase price is fixed in such manner that the bank gets back its principal sum along with profit, which is

usually determined in advance.

Page | 88

established the blue print of a modern Islamic banking system in 1983, which later

enabled the government to establish an Islamic bank and to issue non-interest bearing

investment certificates.

The establishment of Bank Islam Malaysia Berhad (BIMB) in July 1983 marked a

milestone for the development of the Islamic financial system in Malaysia. BIMB carries

out banking business similar to other commercial banks, but along the principles of

Islamic laws (Shariah). The bank offers deposit-taking products such as current and

savings deposit under the concept of Wadiah (guaranteed custody) and investment

deposits under the concept of Mudarabah (profit-sharing). The bank grants finance

facilities such as working capital financing under Murabaha35

(cost-plus financing),

house financing under Bai' Bithaman Ajil (deferred payment sale), leasing under Ijara

(leasing) and project financing under Musharikah (joint venture). BIMB has grown

tremendously since its inception. It was listed on the Main Board of the Kuala Lumpur

Stock Exchange on 17 January 1992. From only RM80 million initially, Bank Islam’s

paid-up capital swelled to RM1.73 billion as at June 2009.

The long-term objective of the Central Bank of Malaysia is to create an Islamic banking

system operate parallel to the conventional banking system. A single Islamic bank

(BIMB) did not represent the whole financial system. It required large number of pro-

active players, wide range of products and innovative instruments, and a vibrant Islamic

money market. Realizing the situation, the Central Bank introduced Interest Free Banking

Scheme (now replaced with Islamic banking scheme (IBS) in March 1993. The scheme

allowed conventional banking institutions to offer Islamic banking products and services

using their existing infrastructure, including staff and branches. Since then, the numbers

of IBS banking institutions have increased to 36 till the end of 2003, comprising 14

commercial banks (of which 4 are foreign banks), 10 finance companies, 5 merchant

35 Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller

declares his cost and profit. Islamic banks have adopted this as a mode of financing. As financing

technique, it involves a request by the client to the bank to purchase a certain item for him. The bank does

that for a definite profit over the cost, which is settled in advance.

Page | 89

banks and 7 discount houses. The Central bank of Malaysia in its annual report (1993,

page no 57) stated:

“With the implementation of the interest free banking scheme, Malaysia has

emerged as the first country to implement a dual banking system, whereby an

Islamic banking system functions on a parallel basis with the conventional

banking system”.

The aspiration to establish a comprehensive Islamic financial system has created a spill-

over effect to the non-bank Islamic financial intermediaries which also started to offer

Islamic financial products and services under Islamic banking scheme. Such institutions

include the Takaful Companies, the savings institutions (i.e. Bank Simpanan Nasional &

Bank Rakyat) and the developmental financial institutions (i.e. Bank Pembangunan dan

Infrastruktur Malaysia and Bank Pertanian.

In October 1996, the Central Bank issued a model financial statement for the IBS banks

requiring them to disclose their Islamic banking operations (balance sheet and profit and

loss account) as an additional item under the Notes to the Accounts. The Central Bank

also setup a National Shariah Advisory Council (NSAC) on Islamic Banking and Takaful

on 1 May 1997. The council considers as the highest Shariah authority on Islamic

banking and Takaful businesses in Malaysia. On October 1, 1999, the Central Bank

issued license for second Islamic bank, Bank Muamalat Malaysia Berhad.

The country also introduced Islamic debt securities market which has made its debut in

1990 with the issuance of RM 125 million Islamic bonds. Islamic Inter-bank Money

Market (IIMM) on January 4, 1994 to link institutions and Islamic investment based

instruments. Since then, both the markets provide variety of securities ranging from two

to five years medium terms Islamic bonds to short-term commercial papers one to twelve

months.

Today, Malaysia has a full-fledged Islamic financial system operating parallel to

conventional financial system. In terms of products and services, there are more than 40

Page | 90

different Islamic financial products currently available in a country. However,

differentiating fixed assets and overhead expenses are problematic in case of IBS banks.

Usually, an IBS bank consists of a team overseeing Islamic banking transactions. Product

development, marketing and other policy issues are conducted at the respective

headquarters. At the branch level, there is no delineation over Islamic and conventional

transactions. Each branch officer is expected to deal with both systems. Islamic and

conventional transactions share the share computers and Automated Teller Machines

(ATMs) facilities. To some extent, overhead expenses on wages/salaries, office

equipment and furniture etc. can be accounted for at the bank’s headquarter, but not at the

branch level. The same applies to security systems, land and office premises as these

cannot be divided into the Islamic and conventional individual components.

Overall Islamic banking industry in Malaysia has continued to register strong expansion

during 2003 to account for 9.7% of the total assets of the banking system (8.9% in 2002),

10.4% of total deposits (10.2% in 2002) and 10.3% of total financing (8.1% in 2002)

(Rosley, 2003). The improved performance was characterized by strong growth in

financing activities for the purchase of transport vehicles and residential property.

The thrust of Islamic financial policy in 2004 continued to be directed at further

strengthening the fundamental essential for progressive Islamic banking industry. The

Central Bank is focusing on strengthening the institutional infrastructure, enhancing the

regulatory framework, strengthening the Shariah and legal infrastructure as well as

enhancing intellectual capital development and consumer education. In 2003, the Central

Bank of Malaysia brought forward liberalization in Islamic banking to allow three full-

fledged foreign Islamic banks to be set-up in Malaysia. Presently Islamic banking and

financial market in Malaysia is as36

:

Islamic banking assets: RM113.5 billion (US$30.9 billion).

Takaful assets: RM6.2 billion (US$1.7 billion).

36 http://www.pwc.com/my/en/issues/islamic-finance-malaysia.jhtml. Retrieved on May 5, 2011.

Page | 91

Largest Islamic private debt securities (IPDS) market: 45.5% (RM125 billion or US$34 billion)

of domestic corporate bonds.

Active Islamic money market channeling about RM30 billion - RM40 billion monthly.

Critical mass of diversified players - Islamic banks, investment banks, takaful companies,

development financial institutions, savings institution, fund management companies, stock

brokers and unit trusts.

The number of full fledged Islamic banks as on may, 2011 are 13.

3.9. Islamic Finance in United Arab Emirates

In UAE for some time now there have been significant developments in the world of

Islamic finance, as major international banks as well as dedicated local retail Islamic

banks focus their attention on a growing customer demand for Shari’ah compliant

financing, investments and insurance products in this country. Islamic finance is

developing at an extraordinary pace, with assets in the industry reaching close to US$750

billion in 2005 with an annual growth rate of more than 15 per cent. And since its

inception over three decades ago, the number of Islamic financial institutions across the

globe has risen from one to over 300, covering more than 75 countries37

. They are, as you

would expect, concentrated in the Middle East and Southeast Asia, but they are also now

appearing in Europe and the United States. The first experiment in the development of

Islamic banking and financial institutions was done in the 1960’s in Egypt. United Arab

Emirates, introduced the first Islamic bank in world known as Dubai Islamic Bank in

1975. In 1999, Dow Jones unveiled the first global stock benchmark for Islamic investors.

Called the Islamic Market Index, it follows 660 Shari’ah compliant companies in 34

countries, including Microsoft and BP Amoco. Nowadays, many banks are introducing

funds tracking this index. In November 1999, the FTSE introduced its own Islamic

indexes working along the same lines. Research suggests that in the Middle East alone,

revenues from oil, if the price remains at or above US$60, will result in a liquidity of

37 http://www.moneyworks.ae/news/archive/3200708.pdf. Retrieved on May 12, 2011.

Page | 92

funds of up to US$1.5 trillion over the next five years from Muslims wishing to invest in

Shari’ah based products and services. The resurgence in Islamic banking and finance

came about post 9/11 due to the migration of funds back to the region, the oil price hike

leading to enhanced liquidity and a demand by pious and cash rich Muslims to manage

their finance in a way that avoids interest and complies with Islamic law. In UAE, the

ongoing growth reflects the influence of other factors, such as the desire for sociopolitical

and economic systems based on Islamic principles and a stronger Islamic identity. In

addition, the introduction of structural reforms in financial systems, the liberalization of

capital movements, privatization and the global integration of financial markets have all

paved the way for the expansion of Islamic finance in UAE. In UAE also, Islamic

banking is no longer for just conservative or radical Muslims. It’s now a mainstream

business as offerings of Islamic mortgages, savings, insurance and retail investment

products become part of a global expansion of this financial sector, which are

increasingly competing with conventional financial products. For a while, international

banks such as HSBC Amanah concentrated on wholesale Islamic banking for major

projects and mutual funds, but it was only a matter of time before the retail Islamic

consumer became a target and Islamic banking started to make massive progress in the

retail space in UAE in general and world in particular. New products - such as Islamic

credit cards and mortgages - and a drive to open more branches to serve the general

consumer are expanding the scope and attractiveness of Islamic banking in UAE. The

industry, it would seem, is capitalizing on its principles to win new customers, while at

the same time going all out to match the traditional banks with services and products.

There is a real commitment to ensure that banking with an Islamic bank does not mean

compromising on either.

Islamic financial institutions in the UAE include Dubai Islamic Bank, HSBC Amanah,

Dubai Bank, National Bank of Sharjah, Abu Dhabi Islamic Bank, Emirates Islamic Bank,

Sharjah Islamic Bank, Amlak, Citi Islamic Bank, NOOR Capital, Saadiq (SCB Islamic

Bank, Badr Al Islami - Mashreq, National Bonds and Tamweel, with most other major

banking institutions offering a range of Shari’ah compliant products and services. . Dubai

Page | 93

Islamic Bank (DIB) and Abu Dhabi Islamic Bank (ADIB) are the key players, with a

53% and 30% Islamic lending market share respectively38

, in addition to Sharjah

Islamic Bank (the former National Bank of Sharjah) and Emirates Islamic Bank

(previously Middle East Bank). The other four banks are Dubai Bank, a conventional

bank which converted to a purely Islamic institution in 2006, Al Noor Islamic Bank

launched by Dubai Holding, and Al Hilal Bank set up by the government of Abu Dhabi.

Ajman has also received initial approval from the UAE Central Bank to set up Ajman

Islamic Bank. In addition to purely Islamic banks, most conventional commercial banks

started to offer Islamic services in the last few years, capitalizing on the recent strong

growth trends. Many conventional banks established fully dedicated Islamic finance

companies (for example, Badr Al Islami by Mashreq bank). Others, including Citibank,

Barclays, and HSBC, have set up Islamic windows within their conventional branches

across the country. Islamic windows mainly focus on ‘deal to deal’ business or sukuk

trading for mega projects. Competition is likely to intensify because of the growing

appetite for Islamic products. However, it is believed that new banks will take some time

to establish themselves properly in the market, probably in two years’ time. It is worth

noting that the Central Bank of UAE is not granting any further full-fledged Islamic

banking licenses, and will approve only Islamic windows or specialized subsidiaries.

3.10. Challenges of Islamic Finance

The Islamic banking industry is experiencing a remarkable period of growth, increasingly

competing directly with conventional banking. Innovation in technology and the world-

wide revolution in information and communication technology are widely perceived to be

a key catalyst of productivity growth. The relationship between IT and Banking is

fundamentally symbiotic. It is expected to reduce costs, increase volumes and facilitate

customised products. Technology adoption is a necessity for Islamic banks to complete

38 http://www.beltoneenclave.com/research/Beltone_UAE_Banking_Sector_Review_for_BE.pdf. Retrieved

on May12, 2011.

Page | 94

with conventional banks. It is a `compulsion’ rather than a `choice? The retention of

existing customers is the primary concern of a majority of the banks today. The main

challenge for banks is to adopt the required technology to provide state-of-the-art

services. Implementation of the right technology should ultimately result in better

customer service, lower costs and improved delivery.

Almost all Islamic financial institutions offer the same basic products, (66 per cent

Murabahah and Ijarah) but the problem is that each institution has its own group of

Islamic scholars on the Shari’ah Board to approve the product. Consequently, the very

same product may have different features and will be subject to different rules in these

institutions. It is necessary to enhance and facilitate the implementation of real Islamic

banking activities i.e. promoting risk sharing through equity-type facilities on the asset

side and profit-sharing investment accounts on the funding side. New products proposed

by Islamic banks should be put under the microscope to explore whether they are Islamic

or not before being issued in the market. There are currently some 60 accounting,

auditing, governance and Shari’ah standards promulgated by the Accounting and

Auditing Organisation for Islamic Financial Institutions (AAOIFI). This body of work is

testimony to the commitment and continuing efforts of AAOIFI since its establishment in

1990 to the development of accounting and auditing standards for Islamic institutions.

However, products continue to develop rapidly and concepts such as ‘fair value’ have

come to centre stage. Conventional accounting standards have responded accordingly.

Two such examples are IAS 39 (Financial Instruments: Recognition and Measurement)

and IFRS 7 (Financial Instruments: Disclosures). Corresponding modifications to existing

AAOIFI standards have not yet been made. This means that, for rating purposes or

competitive reasons, Islamic banks may need to follow IFRS where AAOIFI standards do

not fully cover the concerned product or disclosure. This lack of equivalent AAOIFI

standards is making difficulties in producing financial statements for Islamic banks.

Additionally, both AAOIFI and Islamic Financial Services Board (IFSB) standards need

to be adopted by more institutions and regulators to reinforce their status as the

benchmark standards in Islamic finance. In this context it is worth noting that the Central

Page | 95

Bank of Kuwait approved the application of the amended capital adequacy ratio (Basel

II) on local Islamic banks with effect from 30 June 2009, according to the daily Kuwait-

based Al Seyassah.

Talent Shortage: The supply of trained or experienced bankers has lagged behind the

expansion of Islamic banking. These training needs affect not only Arab domestic banks,

both Islamic and non-Islamic, but foreign banks as well. There is also a need to improve

corporate governance. The institutional aspects of banking operations must be

strengthened to enhance efficiency, transparency, and accountability. Islamic banks need

to take strides in implementing sound corporate governance practices. Similar efforts

should then be undertaken to enhance transparency, which include, among others, the

shift to international standards of financial accounting to align Islamic banks’ policies

with global conventions but taking Islamic values into consideration. The establishment

of credit information and credit ratings agencies will also be beneficial to promote

responsible borrowing and strengthen market discipline and social responsibility. To

improve standards for accountability, setting up compliance systems and the appointment

of compliance officers will be beneficial to ensure banks’ conformity with corporate

governance practices. Also the stakeholders such as accountants, auditors, compliance

officers, financial analysts, corporations, business media, Shari’ah scholars and minority

shareholders must be engaged in the cause for good corporate governance.

Islamic banks have been established as separate legal entities; therefore, their

relationships with central banks and/or other commercial banks are uncertain. Problems

may be further aggravated when an Islamic bank is established in a non-Muslim nation,

and is subject to that nation’s rules and requirements. When comparing with conventional

banking, Islamic financial intuitions rely more heavily on their equity financing, face

more difficulties in attracting deposits, have higher cash/deposit ratios and tend to

channel their funds into direct investment (using Musharaka and Mudarabah products).

Keeping the customer satisfied is the best guarantee for the stability of the organisation in

the long-run. Islamic banks can satisfy their customers only by providing customised,

cost effective and timely services .With the help of technology banks are able to provide

Page | 96

a plethora of products and services. Major services provided by the Islamic banks that are

of international standards are online ‘any time’ banking, ‘anywhere’ banking, global

ATM access and covered cards, etc.

The Right People: The core function of Human Resource Development in the Islamic

banking industry is to facilitate performance improvement, measured not only in terms of

financial indicators of operational efficiency but also in terms of quality of financial

services provided. The skill level, attitude and knowledge of the personnel play an

important role in determining the competitiveness of a bank. Banks must understand that

capital and technology – often considered to be the most important pillars of banking -

are replicable. Human capital, which needs to be viewed as a valuable resource for the

achievement of competitive advantage, is not. The primary concern of the bank should be

to bring in proper integration of human resource management strategies with business

strategies. It should foster cohesive team work and create commitment to improve the

efficiency of its human capital. More than operational skills, today’s banking calls for

these `soft skills’ to attend the needs and requirement of the customers at the counter.

The Islamic banking industry is facing new challenges in terms of narrowing spreads,

new banking products, new players and mergers and acquisitions. The adoption of risk

management tools and new information technology is now no more a choice but a

business compulsion. Technology, product innovation, sophisticated risk management

systems and cost efficiencies leading to the generation of new income streams and the

building of business volumes will be the key to success of banks in this new era. Banks

need to understand clearly what customers want and structure their products and services

accordingly, while taking Shari’ah into account as a paramount consideration.

Page | 97

Summary

Islamic finance is based on shariah principles, so all products are screened through

shariah process and then only the same are issued in the market. Interest (riba/usury) is

forbidden in both Qur’an and Sunnah. It is therefore necessary for Muslims to avoid

receiving and paying of interest. A number of financial banks and institutions are

established and operating whose financial products and services are shariah compliant

based and devoid of any element of interest. These funds pooled under shariah based

principle of banking and financial business by these institutions constitute the Islamic

financial assets or Islamic finance. The overview of the performance of Islamic finance

reveals that the Islamic financial assets have undergone a two-fold growth within a short

period 2009 over 2006. The equity funds occupy the largest portion of Islamic financial

assets at 35 % and the leading country is Iran in the world map of Islamic finance.

Encouraging as the growth of Islamic finance is, there are still challenges ahead for the

Islamic financial institutions to encounter while concurrently operating with interest

based banking institutions. These challenges range in terms of widening the market for

Islamic finance, innovative profitable financial products, adoption of risk management

tools, etc. Islamic banks and financial institutions need to restructure their products

according to the needs of their clientel.

Page | 98

References

Abu Saud, M. (1983). Money, Interest and Qirad in Islam. Studies in Islamic Economics,

The Islamic Foundation , Leicester, UK , p.64

Abu-Zahrah, M. (1970). Buhuth fi al-Riba. Dar al-Buhuth al-Islamiyyah, Kuwait,

pp. 53-54.

Ahmad, M. M. (2008). Islamic Economy. Anmol Publications Pvt. Ltd. New

Delhi.

Al-Harran, S. (1993). Islamic Finance: Partnership Finance. Pelanduk Publications, Kuala

Lumpur, Malaysia, p.6

Chapra, M. U. (2006). The Nature of Riba in Islam. The Journal of Islamic

Economics and Finance, Bangladesh. Vol.2, No.1.

Galloux, M. (1997). Finance islamique et pouvoir politique: le cas de l’Egypte

moderne. Paris: Presses Universitaires de France, p. 103.

Harrod, R. (1973). Towards a Dynamic Economics, London, pp.58-81.

Heikal, M. H. (1983). Autumn of Fury: The Assassination of Sadat. New York:

Random House.

Henry, C. M. (1996). The Mediterranean Debt Crescent: Money and Power in

Algeria, Egypt, Morocco, Tunisia and Turkey. University Press of Florida, p. 22.

Ibn-Arabi, A. B. M. (d. 543/1148) (1957). Ahkam al-Qur’an. Cairo: Al-Matba’ah

al-Bahiyyah al-Misriyyah.

Karawan, I. A. (1992). Monarchs, Mullas and Marshalls: Islamic Regimes?, in

Charles E. Butterworth and I. William Zartman, Political Islam, The Annals of

the American Academy of Political and Social Science, November, pp. 107–10.

Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. London,

p.22.

Page | 99

Mortimer, E. (1982). Faith and Power: The Politics of Islam. New York: Random

House, p. 219.

Nomani, F. & Rahnema, A. (1994). Islamic Economic Systems. New Jersey: Zed

books limited, pp. 3-4.

Patinkin, D. (1972). Studies in Monetary Economics. Harper and Row, New York, 1972,

p.118

Richards, A. (1993). Economic Imperatives and Political Systems. Middle East

Journal, spring, p. 225.

Samuelson, P. (1976). Economics (10th Edition). McGraw Hill, New York, p.50

Udovitch, A. (1970). Partnership and Profit in Medieval Islam. Princeton, NJ:

Princeton University Press, p. 86.