Islamic banking

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  • 1.ISLAMIC BANKING TY.BMSPREFACEThe Islamic banking experiment is still new and is still in the earlystage of application. So it is not surprising that members of the public havemany questions to ask as they are keen on understanding Islamic bankingprinciples and interested in dealing with Islamic institutions. The Islamicbanking experiment is not an innovation but is indeed a continuation ofeconomic thought that has prevailed and survived for many years during whichit proved its success in the filed of practical application for many centuriesduring the early Islamic era. Islamic economic thought has been characterizedby the continuation and variety of its interpretation and development of its tools.During the last fourteen years Islamic banks underwent a number of tests, someof which were fairly difficult that could not be overcome by well-establishedbanks which rely on usury in their transactions. However, with the grace ofGod, foresight of Islamic bankers and hard work of the bank employees suchtests were successfully overcome which proves the sound principles andfoundations of the Islamic banking experiment. Since the problems faced bycertain Islamic banks influence other similar banks either in a negative orpositive manner. Such problems also influence the Islamic economic pursuits ingeneral, and the activities of Islamic banks wherever, and the activities ofIslamic banks where they based in particular. Therefore, there is a need forIslamic banks to adopt a position, reflecting the unity and solidarity of Muslimsand demonstrating their profound belief. Their attitude is one which reflectstheir common destiny and their pursuit of an economic and financial strategy1

2. ISLAMIC BANKING TY.BMSthat is based upon their Islamic religion which regulates, in a comprehensiveway, their financial life. but it is a concept that has been put in practice.Nowadays Islamic banking.. There are Islamic banks effectively operating in three continents of the world.As they entered the second decade, the Islamic banking experience has provedits existence in the financial activities involving both the private and publicsectors. Through the adoption of Islamic finance methods, they have been able tointroduce financial tools that are acceptable in todays world and these facilitiesare less burdensome to the owners of development projects. Throughencouraging participation in projects, Islamic banks have highlighted the key toThird World developing efforts. Short term finance aiming at making securequick profit that is remote from accepting any risks is not in any wayappropriate for development. Without participation in risks, Western Europe forexample would not have accomplished this level of development nor would thedreams of the earlier generation of the Japanese people have become a reality.Islamic economists look forward to establishing a dynamic global economy inwhich capital interacts with human efforts and thought without depending onrates of interest fixed well in advance. With this aspiration, the soundness ofwhich is confirmed by many western and eastern thinkers, the whole world willenjoy greater economic prosperity. This project throws some light on theactivities of Islamic banks while outlining the philosophy of these activities.2 3. ISLAMIC BANKING TY.BMS OBJECTIVES TO STUDY:1. To know about ISLAMIC BANKING.2. To know whether Islamic Banking will be beneficial for the country in future.3. To know about Islamic finance sector.4. To know about development and growth in Islamic banking.5. To know whether Islamic Banking will be beneficial for the customer in future. METHODOLOGY 1. Reviewed secondary sources of data available throughrelevant books, periodicals, internet, relevasnt articles in thenewspapers etc. 2. Primary research was also conducted through a field visit toIslamic Research Foundation (IRF) at Sandhurst Road, Mumbai. 3 4. ISLAMIC BANKING TY.BMS 4 5. ISLAMIC BANKING TY.BMSCH. 1 . Islamic banking Islamic banking refers to a system of banking or banking activity that isconsistent with the principles of Islamic law (Sharia) and its practicalapplication through the development of Islamic economics. Sharia prohibits thepayment of fees for the renting of money (Riba, usury) for specific terms, aswell as investing in businesses that provide goods or services consideredcontrary to its principles (Haraam, forbidden). While these principles were usedas the basis for a flourishing economy in earlier times, it is only in the late 20thcentury that a number of Islamic banks were formed to apply these principles toprivate or semi-private commercial institutions within the Muslim community. History of Islamic banking Classical Islamic banking During the Islamic Golden Age, early forms of proto-capitalism and freemarkets were present in the Caliphate, where an early market economy and anearly form of mercantilism were developed between the 8th-12th centuries,which some refer to as "Islamic capitalism". A vigorous monetary economy wascreated on the basis of the expanding levels of circulation of a stable high-valuecurrency (the dinar) and the integration of monetary areas that were previouslyindependent.A number of innovative concepts and techniques were introduced in earlyIslamic banking, including bills of exchange, the first forms of partnership(mufawada) such as limited partnerships (mudaraba), and the earliest forms ofcapital (al-mal), capital accumulation (nama al-mal), cheques, promissorynotes, trusts (see Waqf), startup companies, transactional accounts, loaning,ledgers and assignments Organizational enterprises similar to corporationsindependent from the state also existed in the medieval Islamic world, while theagency institution was also introduced. Many of these early capitalist 5 6. ISLAMIC BANKING TY.BMSconcepts were adopted and further advanced in medieval Europe from the 13thcentury onwards. Riba The definition of riba in classical Islamic jurisprudence was "surplusvalue without counterpart." or "to ensure equivalency in real value" and that"numerical value was immaterial." During this period, gold and silver currencieswere the benchmark metals that defined the value of all other materials beingtraded. Applying interest to the benchmark itself (ex natura sua) made nological sense as its value remained constant relative to all other materials: thesemetals could be added to but not created (from nothing).Applying interest wasacceptable under some circumstances. Currencies that were based on guaranteesby a government to honor the stated value (i.e. fiat currency) or based on othermaterials such as paper or base metals were allowed to have interest applied tothem. When base metal currencies were first introduced in the Islamic world, nojurist ever thought that "paying a debt in a higher number of units of this fiatmoney was riba" as they were concerned with the real value of money(determined by weight only) rather than the numerical value. For example, itwas acceptable for a loan of 1000 gold dinars to be paid back as 1050 dinars ofequal aggregate weight (i.e., the value in terms of weight had to be samebecause all makes of coins did not carry exactly similar weight).6 7. ISLAMIC BANKING TY.BMS Modern Islamic banking The first modern experiment with Islamic banking was undertaken inEgypt under cover without projecting an Islamic image for fear of being seen asa manifestation of Islamic fundamentalism that was anathema to the politicalregime. The pioneering effort, led by Ahmad Elnaggar, took the form of asavings bankbased onprofit-sharingin the Egyptiantown of MitGhamrin1963. Thisexperimentlasteduntil1967(Ready1981),bywhich timethere were nine such banks in the country. In 1972, the Mit Ghamr Savings project became part of Nasr Social Bankwhich, till date, is still in business in Egypt. In 1975, the Islamic DevelopmentBank was set-up with the mission to provide funding to projects in the membercountries. The first modern commercial Islamic bank, Dubai Islamic Bank,opened its doors in 1975. In the early years, the products offered were basic andstrongly founded on conventional banking products, but in the last few years the7 8. ISLAMIC BANKING TY.BMSindustry is starting to see strong development in new products andservices.Islamic Banking is growing at a rate of 10-15% per year and with signsof consistent future growth. Islamic banks have more than 300 institutionsspread over 51 countries, plus an additional 250 mutual funds that comply withthe Islamic principles. The relative stability of Islamic banking institutions incurrent recession has gained it attention. Even The Vatican said banks shouldlook at the rules of Islamic finance to restore confidence amongst their clients ata time of global economic crisis. The World Islamic Banking Conference, heldannually in Bahrain since 1994, is internationally recognized as the largest andmost significant gathering of Islamic banking and finance leaders in the world. PrinciplesIslamic banking has the same purpose as conventional banking exceptthat it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamicbanking is the sharing of profit and loss and the prohibition of riba (usury).Amongst the common Islamic concepts used in Islamic banking are profitsharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah),cost plus (Murabahah), and leasing (Ijarah).In an Islamic mortgagetransaction, instead of loaning the buyer money to purchase the item, a bankmight buy the item itself from the seller, and re-sell it to the buyer at a profit,while allowing the buyer to pay the bank in installments. However, the fact thatit is profit cannot be made explicit and therefore there are no additional penaltiesfor late payment. In order to protect itself against default, the bank asks for strictcollateral. The goods or land is registered to the name of the buyer from the startof