Islamic Banking 4

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Illustrates the history and emerging trends in Islamic Finance and Banking

Transcript of Islamic Banking 4

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Introduction.2 Fundamentals of Islamic Banking3 Common Islamic Banking Products..5 United Kingdom Laws and the growth of Islamic Banking .5 The Financial Services and Markets Act 2000...........................................................................9 Promotion of Islamic Financial Products.................................................................................10 The Role KPMG.......................................................................................................................12 Regulation of Islamic Banking.13 Specific Cases Involving Islamic Banking...14 Contrast with a Muslim Country..............................................................................................17 The role of Islamic Scholars.17 Criticism of Islamic Banking...................................................................................................19 Latest developments in the industry.19 Conclusion20 List of References.22 Appendix: Abbreviation...........................................................................................................27

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Introduction Since the first Islamic Bank, Mit Ghamr Saving Bank was set up in Egypt in 1963, Islamic banking has grown considerably over the last few years (at 15-20% per annum). It has taken root in over 75 countries worldwide. With over 1.3 billion Muslims worldwide, even the largest banks in the world will respond if even one percent of them demand Islamic compliant financial services. This paper seeks to explore how the world and specifically the United Kingdom have responded legislatively to the growth in Islamic Banking and how these Legislations have influenced Islamic financial services. Background information on Islamic financing is explored to paint the differences that exist between Islamic financing and conventional methods and the fresh challenges they present.1 Islamic finance institutions exist in an environment where Sharia law co-exists with national laws. Therefore, the documents involved in financial transactions must comply with both national and Sharia laws. In countries such as Saudi Arabia where Islamic law is the ultimate law, this may not be a challenge at all. However, in western countries like the UK, where the environment is non-Islamic, complications arise if parties involved are of different jurisdictions (Muslim and non-Muslim). In the past, certain rulings have sparked uncertainty amongst investors and other participants in the financial sector as regards the security of their investments. For these purposes, this paper also looks at some landmark rulings involving such disputes.2 Fundamentals of Islamic Finance1

M. Ayub, Understanding Islamic Finance. (New Jersey: John Wiley & Sons, 2007), 12.2

S. Zubair, Islamic Finance. (New Delhi: Markazi Maktaba Islami Publishers, 2009),

18.

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The financial sector in any country is made up of deficit financial units (borrowers) and surplus units (savers). There are also the firms that play the intermediary role including deposit taking financial institutions. Savers give up current consumption and are compensated through interest on their savings. Borrowers pay interest on the amount they borrow which is used to compensate savers as well as forming part of the intermediarys revenue. The longer the period allowed for payment the higher the returns involved. This is referred to as the time preference theory of interest.3 The Islamic financial system differs with the just described one in that Islamic laws do not allow taking of usury/interest on loans. Islamic banking, which is sometimes referred to as participant banking is consistent with Sharia laws, which prohibit taking and collection of riba or interest. The Islamic laws also prohibit investment in ventures involving goods considered haraam like alcohol, pork, armaments and pornography. The laws do not permit getting involved in contracts where the ownership of commodities depends on uncertain events. Speculative businesses too are unlawful since the high risk and as such encourage unethical behaviour. Sharia law also requires Muslims, to donate a part of their incomeZakat, to charity. Islamic principles also insist that the investor and investee must share risk, profit and losses fairly. Tangible assets must also back all financial transactions. These laws form the basis of the Islamic financial system.4 The Islamic financial system has been accepted worldwide, and even accountants have been trained accordingly. A good example is the Institute of Chartered Accountants of3

I.Warde, Islamic Finance in the Global Economy. ( Edinburgh:Edinburgh University Press, 2000), 22.4

Qudeeer. Latif, Islamic finance. Journal of International Banking and Financial

Law, 21/1 (2006), 10-13.

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Pakistan, which offers Islamic Financial Accounting Standards (IFAS). In most countries where banks offer Sharia compliant services, these banks are expected to have an advisory and somewhat oversight board. There are also firms coming up whose sole role is advising on Islamic compliant financing. The Worldwide Database for Islamic Banking and Financing is one such database, which stores information on all banks, which deal with Sharia compliant financing.5 It is used globally as a benchmark prerequisite for professionals dealing in Islamic Finance. The Advisory Council administers the test for Islamic Finance, which draws members from the Middle East and the UK. The assessment mainly tests the candidates on Islamic banking and Islamic law of contracts including Mudaraba, Murabaha, Ijara and Musharaka. The test also emphasizes the need to understand Islamic financial statements, which differ slightly with conventional statements. Aimed at existing and new employees in law firms and banking industry, the test aims at boosting candidates understanding if Islamic Financing. The continued administering will also increase the number of experts in the nascent field.6

Islamic Banking Products

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Taqi Usmani, Islamic Finance: Musharakah & Mudarbah. Journal of Islamic Banking and Finance, 25/3 (2008), 41-53.6

Rahail Ali, Islamic Finance: A Practical Guide. (London: Globe Business

Publishers, 2008), 34.

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Some of the common Islamic Banking products available in the United Kingdom include Murabaha. This product, which replaced conventional inter-bank deposits, involves the sale and subsequent re-purchase of a commodity traded on a major exchange. Its structure is such that it is similar to a loan by the seller to the buyer. The return for the seller is the difference between sales and re-purchase price. Ijara is another product, which is an agreement where the bank buys and leases a commodity asset to a customer for predetermined money consideration instalments over a stated length of time. The bank may preserve the right to vary the rental charges in line with changes in the cost of financing. This arrangement can be used for purposes of "Islamic compliant mortgages". This usually entails the customer making two payments types, capital payments and rental charge. Ownership passes to the customer once all payments are completed. Other common products are mudaraba and musharaka.7 The United Kingdom Laws As mentioned, Britain hosts the largest value of assets in a non-Muslim country. This success stems from deliberate collaboration between the government and Islamic finance providers. Despite that, the United Kingdom has its own established churches, separation of the roles of the state and the church is seen to be an important condition to uphold. This is known as the doctrine of separation of powers in legal terms. Thus, the law does not discriminate individuals or institution because of their religion. In addition, the state cannot be an arbiter in religious matters. The government has no role in determining whether a business is Sharia compliant. 8Individuals have a right to establish any business as long as it is dispenses in the legal context irrespective of their religion. This is because the legal7

Babacar Mbengue, Islamic Finance, Law, Economics and Practices. Journal of

Islamic and Culture, 12/2 (2010), 183-185.

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enforceability of a contract is not dependent on Sharia compliant. Scholars who interpret the law establish standards of Sharia compliancy. The explanation known as Fiqh may differ between scholars depending on the method of reasoning used. As earlier highlighted, when the laws governing the financial services sector were made, the environment was such that everything was conventional. However, the UK has supported the development of the Islamic compliant products over the last few decades for two major reasons. First is because it seeks financial inclusion of all people, Muslims or otherwise. Developing of products suitable for all is important no matter their religious affiliation. The British government has other interests like maintaining London as a leading financial services center since it comes with great business benefits. 9To achieve this, Islamic financing is almost inevitable. The support to this kind of banking has come in two ways: financial and legislative means. The British government has continually given financial support to Islamic Finance mainly for promotional activities. However, the greatest impact has been felt in legislative efforts. The main purpose is to ensure tax laws do not treat Islamic Banking products any worse or better than conventional products. The efforts are aimed at removing any barriers to Islamic Banking in the UK.10

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Kilian Balz, Murabaha Transaction in English Court, Islamic Law and Society, 11/1 (2004), 117-134.

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Muhammad Marjan, The Implementation of Ibra in Islamic Banking and Finance: An Analysis in Terms of Banking Operations and Maqasid Shariah. ISRA