Islamic Banking Wikipedia

7/31/2019 Islamic Banking Wikipedia

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This article needs additionalcitationsforverification. Please helpimprove this articleby adding citations toreliable sources. Unsourced material may bechallengedandremoved.(January 2008)

BankingA series on financial services

Types of banks[show]

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Bank cards[show]

Electronic funds transfer[show]

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Finance series[show]

v t e

Islamic banking (or participant banking) (Arabic: ) isbankingor banking

activity that is consistent with the principles ofIslamic law(Sharia) and its practical applicationthrough the development ofIslamic economics. Sharia prohibits the fixed or floating payment oracceptance of specific interest or fees (known asriba, orusury) for loans of money. Investing inbusinesses that provide goods or services considered contrary to Islamic principles is alsoharaam("sinful"). Although theseprincipleshave been applied in varying degrees by historicalIslamic economies due to lack of Islamic practice, only in the late 20th century were a number ofIslamic banks were formed to apply these principles toprivateor semi-privatecommercialinstitutions within the Muslim community.[1][2]
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ipedia.org/wiki/Wikipedia:Citing_sources#Inline_citations


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Contents

1 History of Islamic bankingo 1.1 Introduction

1.1.1 Ribao 1.2 Modern Islamic banking

1.2.1 Largest Islamic banks 2 Principles 3 Shariah Advisory Council/Consultant 4 Islamic Financial Accounting Standards 5 Fundamentals of Islamic finance 6 Usury in Islam 7 Islamic financial transaction terminology

o 7.1 Bai' al 'inah (sale and buy-back agreement)o 7.2 Bai' bithaman ajil (deferred payment sale)o 7.3 Bai' muajjal (credit sale)o 7.4 Musharakaho 7.5 Mudarabaho 7.6 Murabahaho 7.7 Musawamaho 7.8 Bai Salam

7.8.1 Basic features and conditions of Salamo 7.9 Hibah (gift)o 7.10 Ijarah

7.10.1 Ijarah thumma al bai' (hire purchase) 7.10.2 Ijarah-wal-iqtina

o 7.11 Musharakah (joint venture)o 7.12 Qard hassan/ Qardul hassan (good loan/benevolent loan)o 7.13 Sukuk (Islamic bonds)o 7.14 Takaful (Islamic insurance)o 7.15 Wadiah (safekeeping)o 7.16 Wakalah (power of attorney)

8 Islamic equity funds 9 Islamic derivatives 10 Islamic laws on trading 11 Microfinance 12 Controversy 13 See also 14 Notes 15 Further reading 16 External links

History of Islamic banking
http://en.wikipedia.org/wiki/Islamic_banking#History_of_Islamic_bankinghttp://en.wikipedia.org/wiki/Islamic_banking#History_of_Islamic_bankinghttp://en.wikipedia.org/wiki/Islamic_banking#Introductionhttp://en.wikipedia.org/wiki/Islamic_banking#Introductionhttp://en.wikipedia.org/wiki/Islamic_banking#Ribahttp://en.wikipedia.org/wiki/Islamic_banking#Ribahttp://en.wikipedia.org/wiki/Islamic_banking#Modern_Islamic_bankinghttp://en.wikipedia.org/wiki/Islamic_banking#Modern_Islamic_bankinghttp://en.wikipedia.org/wiki/Islamic_banking#Largest_Islamic_bankshttp://en.wikipedia.org/wiki/Islamic_banking#Largest_Islamic_bankshttp://en.wikipedia.org/wiki/Islamic_banking#Principleshttp://en.wikipedia.org/wiki/Islamic_banking#Principleshttp://en.wikipedia.org/wiki/Islamic_banking#Shariah_Advisory_Council.2FConsultanthttp://en.wikipedia.org/wiki/Islamic_banking#Shariah_Advisory_Council.2FConsultanthttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_Financial_Accounting_Standardshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_Financial_Accounting_Standardshttp://en.wikipedia.org/wiki/Islamic_banking#Fundamentals_of_Islamic_financehttp://en.wikipedia.org/wiki/Islamic_banking#Fundamentals_of_Islamic_financehttp://en.wikipedia.org/wiki/Islamic_banking#Usury_in_Islamhttp://en.wikipedia.org/wiki/Islamic_banking#Usury_in_Islamhttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_financial_transaction_terminologyhttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_financial_transaction_terminologyhttp://en.wikipedia.org/wiki/Islamic_banking#Bai.27_al_.27inah_.28sale_and_buy-back_agreement.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_al_.27inah_.28sale_and_buy-back_agreement.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_bithaman_ajil_.28deferred_payment_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_bithaman_ajil_.28deferred_payment_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_muajjal_.28credit_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_muajjal_.28credit_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Musharakahhttp://en.wikipedia.org/wiki/Islamic_banking#Musharakahhttp://en.wikipedia.org/wiki/Islamic_banking#Mudarabahhttp://en.wikipedia.org/wiki/Islamic_banking#Mudarabahhttp://en.wikipedia.org/wiki/Islamic_banking#Murabahahhttp://en.wikipedia.org/wiki/Islamic_banking#Murabahahhttp://en.wikipedia.org/wiki/Islamic_banking#Musawamahhttp://en.wikipedia.org/wiki/Islamic_banking#Musawamahhttp://en.wikipedia.org/wiki/Islamic_banking#Bai_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Bai_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Basic_features_and_conditions_of_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Basic_features_and_conditions_of_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Hibah_.28gift.29http://en.wikipedia.org/wiki/Islamic_banking#Hibah_.28gift.29http://en.wikipedia.org/wiki/Islamic_banking#Ijarahhttp://en.wikipedia.org/wiki/Islamic_banking#Ijarahhttp://en.wikipedia.org/wiki/Islamic_banking#Ijarah_thumma_al_bai.27_.28hire_purchase.29http://en.wikipedia.org/wiki/Islamic_banking#Ijarah_thumma_al_bai.27_.28hire_purchase.29http://en.wikipedia.org/wiki/Islamic_banking#Ijarah-wal-iqtinahttp://en.wikipedia.org/wiki/Islamic_banking#Ijarah-wal-iqtinahttp://en.wikipedia.org/wiki/Islamic_banking#Musharakah_.28joint_venture.29http://en.wikipedia.org/wiki/Islamic_banking#Musharakah_.28joint_venture.29http://en.wikipedia.org/wiki/Islamic_banking#Qard_hassan.2F_Qardul_hassan_.28good_loan.2Fbenevolent_loan.29http://en.wikipedia.org/wiki/Islamic_banking#Qard_hassan.2F_Qardul_hassan_.28good_loan.2Fbenevolent_loan.29http://en.wikipedia.org/wiki/Islamic_banking#Sukuk_.28Islamic_bonds.29http://en.wikipedia.org/wiki/Islamic_banking#Sukuk_.28Islamic_bonds.29http://en.wikipedia.org/wiki/Islamic_banking#Takaful_.28Islamic_insurance.29http://en.wikipedia.org/wiki/Islamic_banking#Takaful_.28Islamic_insurance.29http://en.wikipedia.org/wiki/Islamic_banking#Wadiah_.28safekeeping.29http://en.wikipedia.org/wiki/Islamic_banking#Wadiah_.28safekeeping.29http://en.wikipedia.org/wiki/Islamic_banking#Wakalah_.28power_of_attorney.29http://en.wikipedia.org/wiki/Islamic_banking#Wakalah_.28power_of_attorney.29http://en.wikipedia.org/wiki/Islamic_banking#Islamic_equity_fundshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_equity_fundshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_derivativeshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_derivativeshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_laws_on_tradinghttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_laws_on_tradinghttp://en.wikipedia.org/wiki/Islamic_banking#Microfinancehttp://en.wikipedia.org/wiki/Islamic_banking#Microfinancehttp://en.wikipedia.org/wiki/Islamic_banking#Controversyhttp://en.wikipedia.org/wiki/Islamic_banking#Controversyhttp://en.wikipedia.org/wiki/Islamic_banking#See_alsohttp://en.wikipedia.org/wiki/Islamic_banking#See_alsohttp://en.wikipedia.org/wiki/Islamic_banking#Noteshttp://en.wikipedia.org/wiki/Islamic_banking#Noteshttp://en.wikipedia.org/wiki/Islamic_banking#Further_readinghttp://en.wikipedia.org/wiki/Islamic_banking#Further_readinghttp://en.wikipedia.org/wiki/Islamic_banking#External_linkshttp://en.wikipedia.org/wiki/Islamic_banking#External_linkshttp://en.wikipedia.org/wiki/Islamic_banking#External_linkshttp://en.wikipedia.org/wiki/Islamic_banking#Further_readinghttp://en.wikipedia.org/wiki/Islamic_banking#Noteshttp://en.wikipedia.org/wiki/Islamic_banking#See_alsohttp://en.wikipedia.org/wiki/Islamic_banking#Controversyhttp://en.wikipedia.org/wiki/Islamic_banking#Microfinancehttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_laws_on_tradinghttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_derivativeshttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_equity_fundshttp://en.wikipedia.org/wiki/Islamic_banking#Wakalah_.28power_of_attorney.29http://en.wikipedia.org/wiki/Islamic_banking#Wadiah_.28safekeeping.29http://en.wikipedia.org/wiki/Islamic_banking#Takaful_.28Islamic_insurance.29http://en.wikipedia.org/wiki/Islamic_banking#Sukuk_.28Islamic_bonds.29http://en.wikipedia.org/wiki/Islamic_banking#Qard_hassan.2F_Qardul_hassan_.28good_loan.2Fbenevolent_loan.29http://en.wikipedia.org/wiki/Islamic_banking#Musharakah_.28joint_venture.29http://en.wikipedia.org/wiki/Islamic_banking#Ijarah-wal-iqtinahttp://en.wikipedia.org/wiki/Islamic_banking#Ijarah_thumma_al_bai.27_.28hire_purchase.29http://en.wikipedia.org/wiki/Islamic_banking#Ijarahhttp://en.wikipedia.org/wiki/Islamic_banking#Hibah_.28gift.29http://en.wikipedia.org/wiki/Islamic_banking#Basic_features_and_conditions_of_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Bai_Salamhttp://en.wikipedia.org/wiki/Islamic_banking#Musawamahhttp://en.wikipedia.org/wiki/Islamic_banking#Murabahahhttp://en.wikipedia.org/wiki/Islamic_banking#Mudarabahhttp://en.wikipedia.org/wiki/Islamic_banking#Musharakahhttp://en.wikipedia.org/wiki/Islamic_banking#Bai.27_muajjal_.28credit_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_bithaman_ajil_.28deferred_payment_sale.29http://en.wikipedia.org/wiki/Islamic_banking#Bai.27_al_.27inah_.28sale_and_buy-back_agreement.29http://en.wikipedia.org/wiki/Islamic_banking#Islamic_financial_transaction_terminologyhttp://en.wikipedia.org/wiki/Islamic_banking#Usury_in_Islamhttp://en.wikipedia.org/wiki/Islamic_banking#Fundamentals_of_Islamic_financehttp://en.wikipedia.org/wiki/Islamic_banking#Islamic_Financial_Accounting_Standardshttp://en.wikipedia.org/wiki/Islamic_banking#Shariah_Advisory_Council.2FConsultanthttp://en.wikipedia.org/wiki/Islamic_banking#Principleshttp://en.wikipedia.org/wiki/Islamic_banking#Largest_Islamic_bankshttp://en.wikipedia.org/wiki/Islamic_banking#Modern_Islamic_bankinghttp://en.wikipedia.org/wiki/Islamic_banking#Ribahttp://en.wikipedia.org/wiki/Islamic_banking#Introductionhttp://en.wikipedia.org/wiki/Islamic_banking#History_of_Islamic_banking


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Introduction

An earlymarket economyand an early form ofmercantilism, sometimes called "Islamiccapitalism", were developed between the eighth and twelfth centuries.[3]Themonetary economyof the period was based on the widely circulatedcurrencythegold dinar, and it tied together

regions that were previously economically independent.

A number of economic concepts and techniques were applied in early Islamic banking, includingbills of exchange,partnership(mufawada, includinglimited partnerships, or mudaraba), andforms ofcapital(al-mal),capital accumulation(nama al-mal),[4]cheques,promissory notes,[5]trusts(seeWaqf),[6]transactional accounts,loaning,ledgersandassignments.[7]Organizationalenterprisesindependent from thestatealso existed in the medieval Islamic world, while theagencyinstitution was also introduced during that time.[8][9]Many of these early capitalistconcepts were adopted and further advanced inmedieval Europefrom the 13th centuryonwards.[4]

Riba

The word "Riba" means excess, increase or addition, which according to Shariah terminology,implies any excess compensation without due consideration (consideration does not include timevalue of money). The definition ofribain classicalIslamic jurisprudencewas "surplus valuewithout counterpart", or "to ensure equivalency in real value", and that "numerical value wasimmaterial."

Applying interest was acceptable under some circumstances. Currencies that were based onguarantees by a government to honor the stated value (i.e.fiat currency) or based on othermaterialssuch as paper orbase metalswere allowed to have interest applied to them.[10]When

base metal currencies were first introduced in the Islamic world, the question of "paying a debt ina higher number of units of thisfiatmoney being riba" was not relevant as the jurists onlyneeded to be concerned with thereal valueof money (determined by weight only) rather than thenumericalvalue. For example, it was acceptable for a loan of 1000 golddinarsto be paid back as1050 dinars of equal aggregate weight (i.e., the value in terms of weight had to be same becauseall makes of coins did not carry exactly similar weight)....

Modern Islamic banking

(1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a moreelaborate exposition by Mawdudi in 1950.[citation needed] The writings of Muhammad Hamidullah

1944, 1955, 1957 and 1962 should be included in this category.[citation needed]

They have allrecognised the need for commercial banks and their perceived "necessary evil," have proposed abanking system based on the concept of Mudarabha - profit and loss sharing.[citation needed]

In the next two decades interest-free banking attracted more attention, partly because of thepolitical interest it created in Pakistan and partly because of the emergence of young Muslimeconomists. Works specifically devoted to this subject began to appear in this period. The firstsuch work is that of Muhammad Uzair (1955).[citation needed] Another set of works emerged in the
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late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.[citation needed]

The early 1970s saw institutional involvement. The Conference of the Finance Ministers of theIslamic Countries held in Karachi in 1970, the Egyptian study in 1972, the First International

Conference on Islamic Economics in Mecca in 1976, and the International Economic Conferencein London in 1977 were the result of such involvement. The involvement of institutions andgovernments led to the application of theory to practice and resulted in the establishment of thefirst interest-free banks. The Islamic Development Bank, an inter-governmental bank establishedin 1975, was born of this process.[11]

The first modern experiment with Islamic banking was undertaken inEgyptunder cover withoutprojecting an Islamic imagefor fear of being seen as a manifestation of Islamicfundamentalism that was anathema to the political regime.[citation needed] The pioneering effort, ledby Ahmad Elnaggar, took the form of a savings bank based on profit-sharing in the Egyptiantown ofMit Ghamrin 1963. This experiment lasted until 1967 (Ready 1981), by which time

there were nine such banks in country.

[12]

This section requiresexpansion.

In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, currently, isstill in business in Egypt. In 1975, theIslamic Development Bankwas set up with the mission toprovide funding to projects in the member countries.[13]The first modern commercial Islamicbank,Dubai Islamic Bank, opened its doors in 1975. In the early years, the products offered werebasic and strongly founded on conventional banking products, but in the last few years theindustry is starting to see strong development in new products and services.

Islamic Banking is growing at a rate of 10-15% per year and with signs of consistent futuregrowth.[14]Islamic banks have more than 300 institutions spread over 51 countries, including theUnited States through companies such as theMichigan-basedUniversity Bank, as well as anadditional 250 mutual funds that comply with Islamic principles. It is estimated that overUS$822 billion worldwide sharia-compliant assets are managed according toThe Economist.[15]This represents approximately 0.5% of total world estimated assets as of 2005.[16]According toCIMBGroup Holdings, Islamic finance is the fastest-growing segment of the global financialsystem and sales of Islamic bonds may rise by 24 percent to $25 billion in 2010.[17]

Addressing the Oman Investment Forum in October 2011, all conventional banks inOmancanoffer Sharia-based financial services upon approval from theCentral Bank of Oman(CBO).[18]

The Vatican has put forward the idea that "the principles of Islamic finance may represent apossible cure for ailing markets."[19]

Largest Islamic banks

See also:Islamic Development Bank
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Shariah-compliant assets reached about $400 billion throughout the world in 2009, according toStandard & Poors Ratings Services, and the potential market is $4 trillion.[20][21]Iran,SaudiArabiaandMalaysiahave the biggest sharia-compliant assets.[22]

In 2009Iranian banksaccounted for about 40 percent of total assets of the world's top 100

Islamic banks.Bank Melli Iran, with assets of $45.5 billion came first, followed by SaudiArabia'sAl Rajhi Bank,Bank Mellatwith $39.7 billion andBank Saderat Iranwith $39.3billion.[23][24]Iran holds the world's largest level of Islamic finance assets valued at $235.3bnwhich is more than double the next country in the ranking with $92bn. Six out of ten top Islamicbanks in the world are Iranian.[25][26][27]In November 2010,The Bankerpublished its latestauthoritative list of the Top 500 Islamic Finance Institutions with Iran topping the list. Seven outof ten top Islamic banks in the world are Iranian according to the list.[28]

Principles

Islamic banking has the same purpose as conventional banking: to make money for the banking

institute by lending out capital. Because Islam forbids simply lending out money at interest (seeriba), Islamic rules on transactions (known as Fiqh al-Muamalat) have been created to avoid thisproblem. The basic technique to avoid the prohibition is the sharing of profit and loss, via termssuch asprofit sharing(Mudharabah), safekeeping (Wadiah),joint venture(Musharakah), costplus (Murabahah), andleasing(Ijar).

In an Islamicmortgagetransaction, instead of loaning the buyer money to purchase the item, abank might buy the item itself from the seller, and re-sell it to the buyer at a profit, whileallowing the buyer to pay the bank in installments. However, the bank's profit cannot be madeexplicit and therefore there are no additional penalties for late payment. In order to protect itselfagainst default, the bank asks for strict collateral. The goods or land is registered to the name of

the buyer from the start of the transaction. This arrangement is calledMurabahah.

Another approach isEIjara wa EIqtina, which is similar to real estate leasing. Islamic bankshandle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to thedebtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, calledMusharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower form apartnership entity, both providing capital at an agreed percentage to purchase the property. Thepartnership entity then rents out the property to the borrower and charges rent. The bank and theborrower will then share the proceeds from this rent based on the current equity share of the

partnership. At the same time, the borrower in the partnership entity also buys the bank's share ofthe property at agreed installments until the full equity is transferred to the borrower and thepartnership is ended. If default occurs, both the bank and the borrower receive a proportion of theproceeds from the sale of the property based on each party's current equity. This method allowsfor floating rates according to the current market rate such as the BLR (base lending rate),especially in a dual-banking system like in Malaysia.
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There are several other approaches used in business transactions. Islamic banks lend their moneyto companies by issuing floating rate interest loans. The floating rate of interest is pegged to thecompany's individual rate of return. Thus the bank's profit on the loan is equal to a certainpercentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is calledMusharaka. Further,Mudaraba is

venture capitalfunding of an entrepreneur who provides labor while financing is provided by thebank so that both profit and risk are shared. Such participatory arrangements betweencapitalandlaborreflect the Islamic view that the borrower must not bear all the risk/cost of a failure,resulting in a balanced distribution of income and not allowing the lender to monopolize theeconomy.

Islamic banking is restricted to Islamically acceptable transactions, which exclude thoseinvolving alcohol, pork, gambling, etc. The aim of this is to engage in onlyethical investing, andmoral purchasing. The Islamic Banking and Finance Database provides more information on thesubject.[29]

In theory, Islamic banking is an example offull-reserve banking, with banks achieving a 100%reserve ratio.[30]However, in practice, this is not the case, and no examples of 100 per centreserve banking are observed.[31]

Islamic banks have grown recently in the Muslim world but are a very small share of the globalbanking system.Micro-lendinginstitutions founded byMuslims, notablyGrameen Bank, useconventional lending practices and are popular in some Muslim nations, especiallyBangladesh,but some do not consider them true Islamic banking. However,Muhammad Yunus, the founderof Grameen Bank and microfinance banking, and other supporters of microfinance, argue thatthe lack ofcollateraland lack of excessiveinterestin micro-lending is consistent with the Islamicprohibition ofusury(riba).[32][33]

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBSbanks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensurethat the operations and activities of the banking institutions comply with Shariah principles. Onthe other hand, there are also those who believe that no form of banking that involves interestpayments can ever comply with the Shariah.[34]

In Malaysia, the National Shariah Advisory Council, which has been set up atBank NegaraMalaysia(BNM), advises BNM on the Shariah aspects of the operations of these institutions and

on their products and services. (See:Islamic banking in Malaysia). In Indonesia the UlamaCouncil serves a similar purpose.

A number of Shariah advisory firms have now emerged to offer Shariah advisory services to theinstitutions offering Islamic financial services. Issue of independence, impartiality and conflictsof interest have also been recently voiced. The WDIBFWorld Database for Islamic Banking andFinancehas been developed to provide information about all the websites related to this type ofbanking.[29]
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Islamic Financial Accounting Standards

TheInstitute of Chartered Accountants of Pakistanissues Islamic Financial AccountingStandards (IFAS) for Islamic Mode of financing. IFAS 1 (issued in 2005) concernsMusharakahandMudarabah. While, IFAS 2 (issued in 2007) relates toIjarah.

Fundamentals of Islamic finance

The term Islamic banking refers to a system of banking or banking activity that is consistentwith Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamiclaw prohibits usury, the collection and payment of interest, also commonly called riba in Islamicdiscourse. In addition, Islamic law prohibits investing in businesses that are considered unlawful,or haraam (such as businesses that sell alcohol or pork, or businesses that produce media such asgossip columns or pornography, which are contrary to Islamic values). Furthermore the Shariahprohibits what is called "Maysir" and "Gharar". Maysir is involved in contracts where the

ownership of a good depends on the occurrence of a predetermined, uncertain event in the futurewhereas Gharar describes speculative transactions. Both concepts involve excessive risk and aresupposed to foster uncertainty and fraudlent behaviour. Therefore the use of all conventionalderivate instruments is impossible in Islamic banking.[35]In the late 20th century, a number ofIslamic banks were created to cater to this particular banking market.

Usury in Islam

The criticism of usury in Islam was well established during the lifetime of the Islamic prophetMuhammadand reinforced by several verses in the Qur'an dating back to around 600 AD. Theoriginal word used for usury in this text was Riba, which literally means excess or addition.

This was accepted to refer directly to interest on loans so that, according to Islamic economistsChoudhury and Malik (1992), by the time of Caliph Umar, the prohibition of interest was a well-established working principle integrated into the Islamic economic system. This interpretation ofusury has not been universally accepted or applied in the Islamic world. A school of Islamicthought which emerged in the 19th Century, led by Sir Sayyed, argues for an interpretativedifferentiation between usury, or consumptional lending, and interest, or lending for commercialinvestment (Ahmed, 1958). Nevertheless, Choudhury and Malik provide evidence for a gradualevolution of the institutions of interest-free financial enterprises across the world (1992: 104).They cite, for instance, the current existence of financial institutions in Iran, Pakistan and SaudiArabia, the Dar-al-Mal-al-Islami in Geneva and Islamic trust companies in North America.

Islamic financial transaction terminology

This section may requirecleanupto meet Wikipedia'squality standards. Nocleanupreasonhas been specified. Please helpimprove this sectionif you can; thetalk pagemaycontain suggestions. (February 2010)

Bai' al 'inah (sale and buy-back agreement)
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Bai' al inah is a financing facility with the underlying buy and sell transactions between thefinancier and the customer. The financier buys an asset from the customer on spot basis. Theprice paid by the financier constitutes the disbursement under the facility. Subsequently the assetis sold to the customer on a deferred-payment basis and the price is payable in installments. Thesecond sale serves to create the obligation on the part of the customer under the facility. There

are differences of opinion amongst the scholars on the permissibility of Bai' al 'inah, howeverthis is practised in Malaysia (A set of strict conditions must be complied) and the likejurisdictions.[36][37]

Bai' bithaman ajil (deferred payment sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes aprofit margin agreed to by both parties. Like Bai' al 'inah, this concept is also used under anIslamic financing facility. Interest payment can be avoided as the customer is paying the saleprice which is not the same as interest charged on a loan. The problem here is that this includeslinking two transactions in one which is forbidden in Islam. The common perception is that this

is simply straightforward charging of interest disguised as a sale.

Bai' muajjal (credit sale)

Literally bai' muajjal means a credit sale. Technically, it is a financing technique adopted byIslamic banks that takes the form ofmurabahahmuajjal. It is a contract in which the bank earnsa profit margin on the purchase price and allows the buyer to pay the price of the commodity at afuture date in a lump sum or in installments. It has to expressly mention cost of the commodityand the margin of profit is mutually agreed. The price fixed for the commodity in such atransaction can be the same as the spot price or higher or lower than the spot price. Bai' muajjalis also called a deferred-payment sale. However, one of the essential descriptions of riba is an

unjustified delay in payment or either increasing or decreasing the price if the payment isimmediate or delayed.

Musharakah

Musharakah (joint venture) is an agreement between two or more partners, whereby each partnerprovides funds to be used in a venture. Profits made are shared between the partners according tothe invested capital. In case of loss, no partner loses capital in the same ratio. If the Bankprovides capital, the same conditions apply. It is this financial risk, according to the Shariah, thatjustifies the bank's claim to part of the profit. Each partner may or may not participate in carryingout the business. A working partner gets a greater profit share compared to a sleeping (non-

working) partner. The difference between Musharaka and Madharaba is that, in Musharaka, eachpartner contributes some capital, whereas in Madharaba, one partner, e.g. A financial institution,provides all the capital and the other partner, the entrepreneur, provides no capital. Note thatMusharaka and Mudarabah commonly overlap.[38]

Mudarabah
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"Mudarabah" is a special kind of partnership where one partner gives money to another forinvesting it in a commercial enterprise. The capital investment comes from the first partner, whois called the "rabb-ul-mal", while the management and work is the exclusive responsibility of theother party, who is called the "mudarib".

The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capitaland the other party providing its specialist knowledge to invest the capital and manage theinvestment project. Profits generated are shared between the parties according to a pre-agreedratio. Compared to Musharaka, in a Mudaraba only the lender of the money ("rabb-ul-mal") mayincur a loss.

Murabahah

Main article:Murabahah

This concept refers to the sale of goods at a price, which includes a profit margin agreed to by

both parties. The purchase and selling price, other costs, and the profit margin must be clearlystated at the time of the sale agreement. The bank is compensated for the time value of its moneyin the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (suchas real estate or a vehicle), with a fixed rate of profit determined by the profit margin. The bankis not compensated for the time value of money outside of the contracted term (i.e., the bankcannot charge additional profit on late payments); however, the asset remains as a mortgage withthe bank until the default is settled.

This type of transaction is similar torent-to-ownarrangements for furniture or appliances that arecommon inNorth Americanstores.

Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by theseller to either costs or asking price. While the seller may or may not have full knowledge of thecost of the item being negotiated, they are under no obligation to reveal these costs as part of thenegotiation process. This difference in obligation by the seller is the key distinction betweenMurabahah and Musawamah with all other rules as described in Murabahah remaining the same.Musawamah is the most common type of trading negotiation seen in Islamic commerce.

Bai Salam

Bai salam means a contract in which advance payment is made for goods to be delivered lateron. The seller undertakes to supply some specific goods to the buyer at a future date in exchangeof an advance price fully paid at the time of contract. It is necessary that the quality of thecommodity intended to be purchased is fully specified leaving no ambiguity leading to dispute.The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals.Barring this, Bai Salam covers almost everything that is capable of being definitely described asto quantity, quality, and workmanship.
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Basic features and conditions of Salam

1. The transaction is considered Salam if the buyer has paid the purchase price to the sellerin full at the time of sale. This is necessary so that the buyer can show that they are notentering into debt with a second party in order to eliminate the debt with the first party,

an act prohibited under Sharia. The idea of Salam is normally different from the othereither in its quality or in its size or weight and their exact specification is not generallypossible.

2. Salam cannot be effected on a particular commodity or on a product of a particular fieldor farm. For example, if the seller undertakes to supply the wheat of a particular field, orthe fruit of a particular tree, the salam will not be valid, because there is a possibility thatthe crop of that particular field or the fruit of that tree is destroyed before delivery, and,given such possibility, the delivery remains uncertain. The same rule is applicable toevery commodity the supply of which is not certain.

3. It is necessary that the quality of the commodity (intended to be purchased throughsalam) is fully specified leaving no ambiguity which may lead to a dispute. All the

possible details in this respect must be expressly mentioned.4. It is also necessary that the quantity of the commodity is agreed upon in unequivocalterms. If the commodity is quantified in weights according to the usage of its traders, itsweight must be determined, and if it is quantified through measures, its exact measureshould be known. What is normally weighed cannot be quantified in measures and viceversa.

5. The exact date and place of delivery must be specified in the contract.6. Salam cannot be effected in respect of things which must be delivered at spot. For

example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah,that the delivery of both be simultaneous. Here, salam cannot work. Similarly, if wheat isbartered for barley, the simultaneous delivery of both is necessary for the validity of sale.Therefore the contract of salam in this case is not allowed.

7. This is the most preferred financing structure and carries higher order Shariahcompliance.

Hibah (gift)

This is a token given voluntarily by a debtor to a debitor in return for a loan. Hibah usually arisesin practice when Islamic banks voluntarily pay their customers a 'gift' on savings accountbalances, representing a portion of the profit made by using those savings account balances inother activities.

It is important to note that while it appears similar to interest, and may, in effect, have the sameoutcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannotbe 'guaranteed.'{akin to Dividends earned by Shares, however it is not time bound but is at thebank's discretion) However, the opportunity of receiving high Hibah will draw in customers'savings, providing the bank with capital necessary to create its profits; if the ventures areprofitable, then some of those profits may be gifted back to its customers as Hibah.[39]

Ijarah
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Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of useor service for a fixed price or wage. Under this concept, the Bank makes available to thecustomer the use of service of assets / equipments such as plant, office automation, motor vehiclefor a fixed period and price.

Ijarah thumma al bai' (hire purchase)

Parties enter into contracts that come into effect serially, to form a complete lease/ buybacktransaction. The first contract is anIjarah that outlines the terms for leasing or renting over afixed period, and the second contract is aBai that triggers a sale or purchase once the term of theIjarah is complete. For example, in a car financing facility, a customer enters into the firstcontract and leases the car from the owner (bank) at an agreed amount over a specific period.When the lease period expires, the second contract comes into effect, which enables the customerto purchase the car at an agreed to price.

The bank generates a profit by determining in advance the cost of the item, its residual value at

the end of the term and the time value or profit margin for the money being invested inpurchasing the product to be leased for the intended term. The combining of these three figuresbecomes the basis for the contract between the Bank and the client for the initial lease contract.

This type of transaction is similar to thecontractum trinius, a legal maneuver used by Europeanbankers and merchants during the Middle Ages to sidestep the Church's prohibition on interestbearing loans. In a contractum, two parties would enter into three concurrent and interrelatedlegal contracts, the net effect being the paying of a fee for the use of money for the term of theloan. The use of concurrent interrelated contracts is also prohibited under Shariah Law.

Ijarah-wal-iqtina

A contract under which an Islamic bank provides equipment, building, or other assets to theclient against an agreed rental together with a unilateral undertaking by the bank or the client thatat the end of the lease period, the ownership in the asset would be transferred to the lessee. Theundertaking or the promise does not become an integral part of the lease contract to make itconditional. The rentals as well as the purchase price are fixed in such manner that the bank getsback its principal sum along with profit over the period of lease.

Musharakah (joint venture)

Musharakah is a relationship between two parties or more that contribute capital to a business

and divide the net profit and loss pro rata. This is often used in investment projects, letters ofcredit, and the purchase or real estate or property. In the case of real estate or property, the bankassess animputed rentand will share it as agreed in advance.[38]All providers of capital areentitled to participate in management, but not necessarily required to do so. The profit isdistributed among the partners in pre-agreed ratios, while the loss is borne by each partnerstrictly in proportion to respective capital contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).[citation needed]
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Qard hassan/ Qardul hassan (good loan/benevolent loan)

ot deriuqer ylno si rotbed eht dna ,sisab lliwdoog a no dednetxe naol a si sihT repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extraamount beyond the principal amount of the loan (without promising it) as a token of appreciation

to the creditor. In the case that the debtor does not pay an extra amount to the creditor, thistransaction is a true interest-free loan. Some Muslims consider this to be the only type of loanthat does not violate the prohibition on 'riba, for it alone is a loan that truly does not compensatethe creditor for the time value of money.

[40]

Sukuk (Islamic bonds)

Main article:Sukuk

Sukuk, plural of Sakk, is the Arabic name for financial certificates that are the Islamicequivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam.

Hence, Sukuk are securities that comply with the Islamic law (Shariah) and its investmentprinciples, which prohibit the charging or paying of interest. Financial assets that comply withthe Islamic law can be classified in accordance with their tradability and non-tradability in thesecondary markets.

Takaful (Islamic insurance)

Main article:Takaful

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of lossdue to misfortunes. Takaful is based on the idea that what is uncertain with respect to an

individual may cease to be uncertain with respect to a very large number of similar individuals.Insurance by combining the risks of many people enables each individual to enjoy the advantageprovided by thelaw of large numbers. See Takaful for details.

Wadiah (safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in thebank and the bank guarantees refund of the entire amount of the deposit, or any part of theoutstanding amount, when the depositor demands it. The depositor, at the bank's discretion, maybe rewarded withHibah (see above) as a form of appreciation for the use of funds by the bank.

Wakalah (power of attorney)

This occurs when a person appoints a representative to undertake transactions on his/her behalf,similar to apower of attorney.

Islamic equity funds
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Main article:Sharia investments

Islamic investment equity funds market is one of the fastest-growing sectors within the Islamicfinancial system. Currently, there are approximately 100 Islamic equity funds worldwide. Thetotal assets managed through these funds currently exceed US$5 billion and is growing by 12

15% per annum. With the continuous interest in the Islamic financial system, there are positivesigns that more funds will be launched. Some Western majors have just joined the fray or arethinking of launching similar Islamic equity products.

Despite these successes, this market has seen a record of poor marketing as emphasis is onproducts and not on addressing the needs of investors. Over the last few years, quite a number offunds have closed down. Most of the funds tend to target high net worth individuals andcorporate institutions, with minimum investments ranging from US$50,000 to as high as US$1million. Target markets for Islamic funds vary, some cater for their local markets, e.g., Malaysiaand Gulf-based investment funds. Others clearly target the Middle East and Gulf regions,neglecting local markets and have been accused of failing to serve Muslim communities.

Since the launch of Islamic equity funds in the early 1990s, there has been the establishment ofcredible equity benchmarks by Dow Jones Islamic market index (Dow Jones IndexespioneeredIslamic investment indexing in 1999) and the FTSE Global Islamic Index Series. The Web sitefailaka.com monitors the performance of Islamic equity funds and provide a comprehensive listof the Islamic funds worldwide.

Islamic derivatives

See also:Financial derivatives

With help of Bahrain-based International Islamic Financial Market and New York-basedInternational Swaps and Derivatives Association, global standards for Islamicderivativeswereset in 2010. The Hedging Master Agreement provides a structure under which institutions cantrade derivatives such as profit-rate andcurrency swaps.[17]

Islamic laws on trading

TheQur'anprohibitsgambling(games of chance involving money). Thehadith, in addition toprohibiting gambling (games of chance), also prohibitsbayu al-gharar(trading in risk, where theArabicword ghararis taken to mean "risk" or excessive uncertainty).

TheHanafimadhab(legal school) in Islam definesghararas "that whose consequences arehidden." TheShafilegal school defined ghararas "that whose nature and consequences arehidden" or "that which admits two possibilities, with the less desirable one being more likely."TheHanbalischool defined it as "that whose consequences are unknown" or "that which isundeliverable, whether it exists or not."Ibn Hazmof theZahirischool wrote "Ghararis wherethe buyer does not know what he bought, or the seller does not know what he sold." The modernscholar of Islam, Professor Mustafa Al-Zarqa, wrote that "Gharar is the sale of probable items
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whose existence or characteristics are not certain, due to the risky nature that makes the tradesimilar to gambling." Other modern scholars, such as Dr. Sami al-Suwailem, have used GameTheory to try and reach a more measured definition of Gharar, defining it as "a zero-sum gamewith unequal payoffs".[41]

There are a number ofhadiththat forbid trading in gharar, often giving specific examples ofgharhartransactions (e.g., selling the birds in the sky or the fish in the water, the catch of thediver, an unborn calf in its mother's womb etc.). Jurists have sought many complete definitionsof the term. They also came up with the concept ofyasir(minor risk); a financial transactionwith a minor risk is deemed to behalal(permissible) while trading in non-minor risk (bayu al-ghasar) is deemed to beharam.[42]

What ghararis, exactly, was never fully decided upon by the Muslim jurists. This was mainlydue to the complication of having to decide what is and is not a minor risk. Derivativesinstruments (such as stock options) have only become common relatively recently. Some Islamicbanks do providebrokerageservices for stock trading.

Microfinance

Microfinanceis a key concern for Muslims states and recently Islamic banks also. Microfinanceis ideologically compatible with Islamic finance, capable of Shariah-compliancy, and possesses asizeable potential market. Islamic microfinance tools can enhance security of tenure andcontribute to transformation of lives of the poor.[43]The use of interest found in conventionalmicrofinance products and services can easily be avoided by creating microfinance hybridsdelivered on the basis of the Islamic contracts of mudaraba, musharaka, and murabahah.Already, several microfinance institutions (MFIs) such asFINCA Afghanistanhave introducedIslamic-compliant financial instruments that accommodate sharia criteria.

Controversy

InIslamabad,Pakistan, on June 16, 2004: Members of leadingIslamistpolitical party inPakistan, theMuttahida Majlis-e-Amal(MMA) party, staged a protest walkout from theNationalAssembly of Pakistanagainst what they termed derogatory remarks by a minority member oninterestbanking:

Taking part in the budget debate, M.P. Bhindara, a minority MNA [Member of the NationalAssembly]...referred to a decree by anAl-Azhar University's scholar that bank interest was notun-Islamic. He said without interest the country could not get foreign loans and could notachieve the desired progress. A pandemonium broke out in the house over his remarks as anumber ofMMAmembers...rose from their seats in protest and tried to respond to Mr Bhindara'sobservations. However, they were not allowed to speak on a point of order that led to theirwalkout.... Later, the opposition members were persuaded by a team of ministers...to return to thehouse...the government team accepted the right of the MMA to respond to the minority member'sremarks.... Sahibzada Fazal Karim said the Council of Islamic ideology had decreed that interest
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in all its forms was haram in an Islamic society. Hence, he said, no member had the right tonegate this settled issue.[44]

Some Islamic banks charge for thetime value of money, the common economic definition ofinterest(riba). These institutions are criticized in some quarters of the Muslim community for

their lack of strict adherence to Sharia.

The concept of Ijarah is used by some Islamic Banks (the Islami Bank in Bangladesh, forexample) to apply to the use of money instead of the more accepted application of supplyinggoods or services using money as a vehicle. A fixed fee is added to the amount of the loan thatmust be paid to the bank regardless if the loan generates a return on investment or not. Thereasoning is that if the amount owed does not change over time, it is profit and not interest andtherefore acceptable under Sharia.

Islamic banks are also criticized by some for not applying the principle of Mudarabah in anacceptable manner. Where Mudarabah stresses the sharing of risk, critics point out that these

banks are eager to take part in profit-sharing but they have little tolerance for risk. To some inthe Muslim community, these banks may be conforming to the strict legal interpretations ofSharia but avoid recognizing the intent that made the law necessary in the first place.[citation needed]

The majority of Islamic banking clients are found in the Gulf states and in developed countries.With 60% of Muslims living in poverty[citation needed], Islamic banking is of little benefit to thegeneral population. The majority of financial institutions that offer Islamic banking services aremajority owned by Non-Muslims. With Muslims working within these organizations beingemployed in the marketing of these services and having little input into the actual day to daymanagement, the veracity of these institutions and their services are viewed with suspicion. OneMalaysian Bank offering Islamic based investment funds was found to have the majority of these

funds invested in the gaming industry; the managers administering these funds were nonMuslim.[44]These types of stories contribute to the general impression within the Muslimpopulace that Islamic banking is simply another means for banks to increase profits throughgrowth of deposits and that only the rich derive benefits from implementation of Islamic Bankingprinciples.

Hence, the controversy that surrounds Islamic Banking continues. The question of whether or notIslamic banking really is Islamic is still a matter of debate among the Muslim academia.

See also

Contractum trinius Full-reserve banking Fractional-reserve banking Islamic economical jurisprudence Islamic banking in Malaysia Reserve requirement Green economics Micro venture capital
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Islamic Banking Wikipedia

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