Islamic Banking

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Transcript of Islamic Banking




What is Bank and Banking?

Common questions about Islamic Banking? What is meant by riba? How does an Islamic bank work? What is the difference between Islamic and conventional banking? What are the main Islamic modes of financing? Is Islamic banking meant for Muslims only? What is the meaning of Takaful? What is the meaning of sukuk?

ISLAMIC BANKINGIslamic Banking is known by several names: Interest free banking Profit and Loss Sharing Banking Islamic Banking Special Finance Houses

Islamic banking is banking or banking activity that is consistent with the principles of Islamic law (Sharia). Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as riba) for loans of money. Investing in businesses that provide goods or services considered opposite to Islamic principles is also haraam (forbidden).

KEY DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC BANKINGConventional Banking 1. The functions and operating modes of conventional banks are based on fully manmade principles. Islamic Banking 1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.

2. The investor is assured of a predetermined 2. In contrast, it promotes risk sharing rate of interest. between provider of capital (investor) and the user of funds (entrepreneur).3. It aims at maximizing profit without any restriction. 3. It also aims at maximizing profit but subject to Shariah restrictions.

4. It does not deal with Zakat.5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks. 6. It can charge additional money (penalty and compounded interest) in case of defaulters.

4. It deals with Zakat.5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well. 6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity.

7. Very often it results in the bank's own interest becoming prominent. It makes no effort to ensure growth with equity. 8. For interest-based commercial banks, borrowing from the money market is relatively easier. 9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations. 10. The conventional banks give greater emphasis on credit-worthiness of the clients. 11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.12. A conventional bank has to guarantee all its deposits.

7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.8. For the Islamic banks, it must be based on a Shariah approved underlying transaction. 9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations. 10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects. 11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller. 12. Islamic bank can only guarantee deposits for deposit account.

Sources of Islamic Law

Various sources of Islamic law are used by Islamic Scholars to explain the Sharia. The primary sources are:

Qur'an: The Qur'an is the holy scripture of Islam. Sunnah: The Sunnah consists of the religious actions and quotations of the Islamic Prophet Muhammad (P.B.U.H) and narrated through his Companions and Imams.Shariah Requirement & Prohibitions

Shariah aspects of Islamic banking and finance revolve around Shariah requirements which refer to:

Avoidance of prohibitions. Ensuring that the contract have all their essential elements with their necessary conditions.

The prohibitions are:

Producing and trading of impure materials Producing and trading of materials which are of no use Riba Gharar

Involvement of gambling


Riba means charging of any interest, meaning money earned on the lending out of money itself. The prohibition on paying or receiving fixed interest is based on the Islamic principle that: Money is only a medium of exchange. A way of defining the value of a thing; it has no value in itself. It should not be allowed to give rise to more money, via fixed interest payments. The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it.

There are two types of Riba: Riba fadhl: is defined as excess compensation without any consideration resulting from a sale of homogeneous goods .

Riba nasiah: is defined as excess, which results from predetermined interest (sood) which a lender receives over and above the principle (Rsul Mal).


Uncertainty in the existence of Subject Matter Uncertainty in the delivery of Subject Matter Un Known

Subject Matter Price Duration Contract

GamblingGambling is betting or charging something which depends on the failure of one or more person. Speculation is not gambling. Some jurists say that speculation is prohibited, but contracts involving speculation are still valid.

Is Islamic Banking for Muslim Only The principles of Islamic Banking, which prohibit charging of interest rates, are humanistic in nature. Islamic banking leads towards freedom from economic slavery. The freedom should be not only of Muslims, but of all. The misunderstanding that Islamic banking is of Muslims only should be changed. It is a democratic banking system. There is not only humaneness and kindness but also productivity in it. It is also a meaningful share-holding. It is a system in which the one who invests and the one who works for the venture share the profit and loss equally. The field of production will enhance if Islamic finance is properly followed.

SOURCE OF FUNDSBesides their own capital and equity, Islamic banks rely on two main sources of funds:

Transaction deposits, which are risk free but yield no return. Investment deposits, which carry the risks of capital loss for the promise of variable.

In all, there are four main types of accounts:

Current accounts Savings accounts Investment accounts Special investment accounts


Bai' al 'inah (sale and buy-back agreement) Bai' bithaman ajil (deferred payment sale) Bai' muajjal (credit sale) Musharakah ( joint venture ) Mudarabah Murabahah Musawamah Bai Salam Hibah (gift) Ijarah (leasing/ rental agreement) Ijarah-wal-iqtina Qard hassan/ Qardul hassan (good loan/benevolent loan) Sukuk (Islamic bonds) Takaful (Islamic insurance) Wadiah (safekeeping) Wakalah (power of attorney)


Sukuk (Islamic bonds) Sukuk, is the Arabic name for financial certificates that are the Islamic equivalent of bonds. Fixed-income, interest-bearing bonds are not permissible in Islam. Sukuk are securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit the charging or paying of interest. Conventional Bonds In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals (semi annual, annual, sometimes monthly)

History Of Sukuk

In classical period of Islam, Sukuk meant any document representing a contract or conveyance of rights, obligations done in conformity with the Shariah. Empirical evidence shows that sukuk were a product extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities. The essence of sukuk, in the modern Islamic perspective, lies in the concept of asset monetization, the so called securitization. It is achieved through the process of issuance of sukuk. Its great potential is in transforming an assets future cash flow into present cash flow. Sukuk may be issued on existing as well as specific assets that may become available at a future date.

Types of Sukuk

Murabahah Sukuk Mudarabah Sukuk Musharakah Sukuk

Ijarah Sukuk

Salam SukukIstisnaa Sukuk

Benefits of Sukuk

Sukuk have great potential for promoting risk sharing. Increasing savings mobilization and investment, spurring growth leading to enhanced welfare. Sukuk is based on an underlying transaction which creates a close link between financial and productive flows. This contributes to greater stability of the financial system. Inder the risk-sharing principle required, there is an explicit sharing of risk by the financier and the borrower. This arrangement will entail the appropriate due diligence and the integration of the risks associated with the real investment activity into the financial transaction.


Sukuk are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sukuk (Islamic bond) effectively requires payment for the time-value of money. Sukuk offer investors fixed return on their investments which is also similar in appearance to interest in that the investor's return is not necessarily dependent on the risks of that particular venture. However, banks that issue Sukuk are i