Islamic Banking

Islamic banking (or participant banking) is banking or banking activity that is consistent with the

principles of Islamic law (Sharia) and its practical application through the development of Islamic

economics. Sharia prohibits the payment or acceptance of specific interest or fees (known as Riba or

usury) for loans of money. Investing in businesses that provide goods or services considered contrary to

Islamic principles is also Haraam (forbidden). While these principles were used as the basis for a

flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks

were formed to apply these principles to private or semi-private commercial institutions within the

Muslim community.

History of Islamic Banking

An early market economy and an early form of mercantilism were developed between the 8th-12th

centuries, which some refer to as "Islamic capitalism". The monetary economy of the period was based

on the widely circulated currency the dinar, and it tied together regions that were previously

economically independent.

A number of economic concepts and techniques were applied in early Islamic banking, including bills of

exchange, partnership (mufawada) such as limited partnerships (mudaraba), and forms of capital (al-

mal), capital accumulation (nama al-mal), cheques, promissory notes, trusts, transactional accounts,

loaning, ledgers and assignments. Organizational enterprises independent from the state also existed in

the medieval Islamic world, while the agency institution was also introduced during that time. Many of

these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th

century onwards.

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 time value of

money). The definition of riba in classical Islamic jurisprudence was "surplus value without counterpart",

or "to ensure equivalency in real value", and that "numerical value was immaterial."

Applying interest was acceptable under some circumstances. Currencies that were based on guarantees

by a government to honor the stated value (i.e. fiat currency) or based on other materials such as paper

or base metals were allowed to have interest applied to them. When base metal currencies were first

introduced in the Islamic world, the question of "paying a debt in a higher number of units of this fiat

money being riba" was not relevant as the jurists only needed to be concerned with the real value of

money (determined by weight only) rather than the numerical value. For example, it was acceptable for

a loan of 1000 gold dinars to be paid back as 1050 dinars of equal aggregate weight (i.e., the value in

terms of weight had to be same because all makes of coins did not carry exactly similar weight).

Modern Islamic Banking

Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of

banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem

Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition

by Mawdudi in 1950. The writings of Muhammad Hamidullah 1944, 1955, 1957 and 1962 should be

included in this category. They have all recognised the need for commercial banks and their perceived

"necessary evil," have proposed a banking system based on the concept of Mudarabha - profit and loss

sharing.

In the next two decades interest-free banking attracted more attention, partly because of the political

interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works

specifically devoted to this subject began to appear in this period. The first such work is that of

Muhammad Uzair (1955). Another set of works emerged in the 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.

The early 1970s saw institutional involvement. The Conference of the Finance Ministers of the Islamic

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 Conference in London in 1977 were

the result of such involvement. The involvement of institutions and governments led to the application

of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic

Development Bank, an inter-governmental bank established in 1975, was born of this process.

The first modern experiment with Islamic banking was undertaken in Egypt under cover without

projecting an Islamic image—for fear of being seen as a manifestation of Islamic fundamentalism that

was anathema to the political regime. The pioneering effort, led by Ahmad Elnaggar, took the form of a

savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted

until 1967 (Ready 1981), by which time there were nine such banks in country.

In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, currently, is still in

business in Egypt. In 1975, the Islamic Development Bank was set up with the mission to provide funding

to projects in the member countries. The first modern commercial Islamic bank, Dubai Islamic Bank,

opened its doors in 1975. In the early years, the products offered were basic and strongly founded on

conventional banking products, but in the last few years the industry 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 future growth.

Islamic banks have more than 300 institutions spread over 51 countries, including the United States

through companies such as the Michigan-based University Bank, as well as an additional 250 mutual

funds that comply with Islamic principles. It is estimated that over US$822 billion worldwide sharia-

compliant assets are managed according to The Economist. This represents approximately 0.5% of total

world estimated assets as of 2005. According to CIMB Group Holdings, Islamic finance is the fastest-

growing segment of the global financial system and sales of Islamic bonds may rise by 24 percent to $25

billion in 2010.

The Vatican has put forward the idea that "the principles of Islamic finance may represent a possible

cure for ailing markets."

Largest Islamic Banks

Shariah-compliant assets reached about $400 billion throughout the world in 2009, according to

Standard & Poor’s Ratings Services, and the potential market is $4 trillion. Iran, Saudi Arabia and

Malaysia have the biggest sharia-compliant assets.

In 2009 Iranian banks accounted 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 Saudi Arabia's Al Rajhi Bank,

Bank Mellat with $39.7 billion and Bank Saderat Iran with $39.3 billion. Iran holds the world's largest

level of Islamic finance assets valued at $235.3bn which is more than double the next country in the

ranking with $92bn. Six out of ten top Islamic banks in the world are Iranian. In November 2010, The

Banker published its latest authoritative list of the Top 500 Islamic Finance Institutions with Iran topping

the list. Seven out of ten top Islamic banks in the world are Iranian according to the list.

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 (see riba), Islamic

rules on transactions (known as Fiqh al-Muamalat) have been created to avoid this problem. The basic

technique to avoid the prohibition is the sharing of profit and loss, via terms such as profit sharing

(Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing

(Ijar).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank

might 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 bank's profit cannot be made explicit and therefore there

are no additional penalties for late payment. In order to protect itself against 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 called Murabahah. Another approach is EIjara wa EIqtina, which is

similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle

at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is

paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows

for a floating rate in the form of rental. The bank and borrower form a partnership entity, both providing

capital at an agreed percentage to purchase the property. The partnership entity then rents out the

property to the borrower and charges rent. The bank and the borrower 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 of the property at agreed installments until the full

equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and

the borrower receive a proportion of the proceeds from the sale of the property based on each party's

current equity. This method allows for floating rates according to the current market rate such as the

BLR (base lending rate), especially in a dual-banking system like in Malaysia.

There are several other approaches used in business transactions. Islamic banks lend their money to

companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's

individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the

company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is

concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an

entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are

shared. Such participatory arrangements between capital and labor reflect 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 the economy.

Islamic banking is restricted to Islamically acceptable transactions, which exclude those involving

alcohol, pork, gambling, etc. The aim of this is to engage in only ethical investing, and moral purchasing.

Islamic Banking and Finance Database provides more information on the subject.

In theory, Islamic banking is an example of full-reserve banking, with banks achieving a 100% reserve

ratio.

However, in practice, this is not the case, and no examples of 100 per cent reserve banking are

observed.

Islamic banks have grown recently in the Muslim world but are a very small share of the global banking

system. Micro-lending institutions founded by Muslims, notably Grameen Bank, use conventional

lending practices and are popular in some Muslim nations, especially Bangladesh, but some do not

consider them true Islamic banking. However, Muhammad Yunus, the founder of Grameen Bank and

microfinance banking, and other supporters of microfinance, argue that the lack of collateral and lack of

excessive interest in micro-lending is consistent with the Islamic prohibition of usury (riba).

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are

required to establish a Shariah Supervisory Board (SSB) to advise them and to ensure that the operations

and activities of the banking institutions comply with Shariah principles. On the other hand, there are

also those who believe that no form of banking that involves interest payments can ever comply with

the Shariah.

In Malaysia, the National Shariah Advisory Council, which has been set up at Bank Negara Malaysia

(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 Ulama Council serves a similar purpose.

A number of Shariah advisory firms have now emerged to offer Shariah advisory services to the

institutions offering Islamic financial services. Issue of independence, impartiality and conflicts of

interest have also been recently voiced. The WDIBF World Database for Islamic Banking and Finance has

been developed to provide information about all the websites related to this type of banking.

Fundamentals of Islamic Finance

The term “Islamic banking” refers to a system of banking or banking activity that is consistent with

Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamic law prohibits

usury, the collection and payment of interest, also commonly called riba in Islamic discourse. 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 as gossip columns or pornography,

which are contrary to Islamic values). Furhermore the Shariah prohibits 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 future whereas Gharar describes speculative transactions. Both

concepts involve excessive risk and are suppposed to foster uncertainty and fraudlent behaviour.

Therefore the use of all conventional derivate instruments is impossible in Islamic banking. In the late

20th century, a number of Islamic 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 Prophet Muhammad and

reinforced by several of verses in the Qur'an dating back to around 600 AD. The original 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 economists Choudhury 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 of usury has not been universally accepted or applied in

the Islamic world. A school of Islamic thought which emerged in the 19th Century, led by Sir Sayyed,

argues for an interpretative differentiation between usury, or consumptional lending, and interest, or

lending for commercial investment (Ahmed, 1958). Nevertheless, Choudhury and Malik provide

evidence for “a gradual evolution 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 Saudi Arabia, the Dar-al-Mal-al-Islami in Geneva and Islamic trust companies in North America. This

growing practice of Islamic banking will be discussed more fully in a later section as a modern

application of usury prohibition.

Islamic Financial Transaction Terminology

Bai' al 'inah (sale and buy-back agreement)

Bai' al inah is a financing facility with the underlying buy and sell transactions between the financier and

the customer. The financier buys an asset from the customer on spot basis. The price paid by the

financier constitutes the disbursement under the facility. Subsequently the asset is sold to the customer

on a deferred-payment basis and the price is payable in installments. The second 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, however this is practised in Malaysia (A set of strict

conditions must be complied) and the like jurisdictions.

Bai' bithaman ajil (Deferred Payment Sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit

margin agreed to by both parties. Like Bai' al 'inah, this concept is also used under an Islamic financing

facility. Interest payment can be avoided as the customer is paying the sale price which is not the same

as interest charged on a loan. The problem here is that this includes linking 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 by Islamic banks

that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin on the

purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or

in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually

agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or

higher or lower than the spot price. Bai' muajjal is 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 is immediate or delayed.

Musharakah

Musharakah (joint venture) is an agreement between two or more partners, whereby each partner

provides funds to be used in a venture. Profits made are shared between the partners according to the

invested capital. In case of loss, each partner loses capital in the same ratio. If the Bank provides capital,

the same conditions apply. It is this financial risk, according to the Shariah, that justifies the bank's claim

to part of the profit. Each partner may or may not participate in carrying out 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, each partner 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 that Musharaka and Madharaba commonly

overlap.

Mudarabah

"Mudarabah" is a special kind of partnership where one partner gives money to another for investing it

in a commercial enterprise. The investment comes from the first partner who is called "rabb-ul-mal",

while the management and work is an exclusive responsibility of the other, who is called "mudarib".

The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capital and the

other party providing its specialist knowledge to invest the capital and manage the investment project.

Profits generated are shared between the parties according to a pre-agreed ratio. Compared to

Musharaka, in a Mudaraba only the lender of the money has to take losses.

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 clearly stated at the

time of the sale agreement. The bank is compensated for the time value of its money in the form of the

profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a

vehicle), with a fixed rate of profit determined by the profit margin. The bank is not compensated for

the time value of money outside of the contracted term (i.e., the bank cannot charge additional profit

on late payments); however, the asset remains as a mortgage with the bank until the default is settled.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are

common in North American stores.

Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by the seller to

either costs or asking price. While the seller may or may not have full knowledge of the cost of the item

being negotiated, they are under no obligation to reveal these costs as part of the negotiation process.

This difference in obligation by the seller is the key distinction between Murabahah 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 later on. The

seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance

price fully paid at the time of contract. It is necessary that the quality of the commodity 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 as to quantity, quality, and workmanship.

Basic Features and Conditions of Salam

1. The transaction is considered Salam if the buyer has paid the purchase price to the seller in full

at the time of sale. This is necessary so that the buyer can show that they are not entering 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 to provide a mechanism that ensures that the seller has the liquidity they expected from

entering into the transaction in the first place. If the price were not paid in full, the basic purpose of the

transaction would have been defeated. Muslim jurists are unanimous in their opinion that full payment

of the purchase price is key for Salam to exist. Imam Malik is also of the opinion that the seller may

defer accepting the funds from the buyer for two or three days, but this delay should not form part of

the agreement.

2. Salam can be effected in those commodities only the quality and quantity of which can be

specified exactly. The things whose quality or quantity is not determined by specification cannot be sold

through the contract of salam. For example, precious stones cannot be sold on the basis of salam,

because every piece of precious stones is normally different from the other either in its quality or in its

size or weight and their exact specification is not generally possible.

3. Salam cannot be effected on a particular commodity or on a product of a particular field or farm.

For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular

tree, the salam will not be valid, because there is a possibility that the 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 to every commodity the supply of which is not certain.

4. It is necessary that the quality of the commodity (intended to be purchased through salam) is

fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect

must be expressly mentioned.

5. It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If

the commodity is quantified in weights according to the usage of its traders, its weight must be

determined, and if it is quantified through measures, its exact measure should be known. What is

normally weighed cannot be quantified in measures and vice versa.

6. The exact date and place of delivery must be specified in the contract.

7. 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 is bartered 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.

Hibah (Gift)

This is a token given voluntarily by a debtor to a debitor in return for a loan. Hibah usually arises in

practice when Islamic banks voluntarily pay their customers a 'gift' on savings account balances,

representing a portion of the profit made by using those savings account balances in other activities.

It is important to note that while it appears similar to interest, and may, in effect, have the same

outcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot be

'guaranteed.' 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 are profitable, then some

of those profits may be gifted back to its customers as Hibah.

Ijarah

Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or service

for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of

service of assets / equipments such as plant, office automation, motor vehicle for 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/ buyback

transaction. The first contract is an Ijarah that outlines the terms for leasing or renting over a fixed

period, and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is

complete. For example, in a car financing facility, a customer enters into the first contract 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 customer to 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 in purchasing the product

to be leased for the intended term. The combining of these three figures becomes the basis for the

contract between the Bank and the client for the initial lease contract.

This type of transaction is similar to the contractum trinius, a legal maneuver used by European bankers

and merchants during the Middle Ages to sidestep the Church's prohibition on interest bearing loans. In

a contractum, two parties would enter into three concurrent and interrelated legal contracts, the net

effect being the paying of a fee for the use of money for the term of the loan. 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 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 rentals as

well as the purchase price are fixed in such manner that the bank gets back its principal sum along with

profit over the period of lease.

Musharakah (Joint Venture)

Musharakah is a relationship between two parties or more, of whom contribute capital to a business,

and divide the net profit and loss pro rata. This is often used in investment projects, letters of credit, and

the purchase or real estate or property. In the case of real estate or property, the bank assess an

imputed rent and will share it as agreed in advance. All providers of capital are entitled to participate in

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

contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).

Qard hassan/ Qardul hassan (Good Loan/Benevolent Loan)

This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount

borrowed. However, the debtor may, at his or her discretion, pay an extra amount 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, this transaction is a true interest-free loan. Some

Muslims consider this to be the only type of loan that does not violate the prohibition on riba, since it is

the one type of loan that truly does not compensate the creditor for the time value of money.

Sukuk (Islamic Bonds)

Sukuk, plural of صك Sakk, is the Arabic name for financial certificates that are the Islamic equivalent 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 investment principles, which prohibit the

charging or paying of interest. Financial assets that comply with the Islamic law can be classified in

accordance with their tradability and non-tradability in the secondary markets.

Takaful (Islamic Insurance)

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due 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 advantage provided by the law 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 the bank and

the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount,

when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with Hibah

(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 a power of attorney.

Islamic Equity Funds

Islamic investment equity funds market is one of the fastest-growing sectors within the Islamic financial

system. Currently, there are approximately 100 Islamic equity funds worldwide. The total 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 positive signs that more funds will be

launched. Some Western majors have just joined the fray or are thinking of launching similar Islamic

equity products.

Despite these successes, this market has seen a record of poor marketing as emphasis is on products

and not on addressing the needs of investors. Over the last few years, quite a number of funds have

closed down. Most of the funds tend to target high net worth individuals and corporate institutions,

with minimum investments ranging from US$50,000 to as high as US$1 million. Target markets for

Islamic funds vary, some cater for their local markets, e.g., Malaysia and 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 of credible

equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneered Islamic

investment indexing in 1999) and the FTSE Global Islamic Index Series. The Web site failaka.com

monitors the performance of Islamic equity funds and provide a comprehensive list of the Islamic funds

worldwide.

Islamic Derivatives

With help of Bahrain-based International Islamic Financial Market and New York-based International

Swaps and

Derivatives Association, global standards for Islamic derivatives were set in 2010. The “Hedging Master

Agreement ” provides a structure under which institutions can trade derivatives such as profit-rate and

currency swaps.

Islamic Laws on Trading

The Qur'an prohibits gambling (games of chance involving money). The hadith, in addition to prohibiting

gambling (games of chance), also prohibits bayu al-gharar (trading in risk, where the Arabic word gharar

is taken to mean "risk" or excessive uncertainty).

The Hanafi madhab (legal school) in Islam defines gharar as "that whose consequences are hidden." The

Shafi legal school defined gharar as "that whose nature and consequences are hidden" or "that which

admits two possibilities, with the less desirable one being more likely." The Hanbali school defined it as

"that whose consequences are unknown" or "that which is undeliverable, whether it exists or not." Ibn

Hazm of the Zahiri school wrote "Gharar is where the buyer does not know what he bought, or the seller

does not know what he sold." The modern scholar of Islam, Professor Mustafa Al-Zarqa, wrote that

"Gharar is the sale of probable items whose existence or characteristics are not certain, due to the risky

nature that makes the trade similar to gambling." Other modern scholars, such as Dr. Sami al-Suwailem,

have used Game Theory to try and reach a more measured definition of Gharar, defining it as "a zero-

sum game with unequal payoffs".

There are a number of hadith that forbid trading in gharar, often giving specific examples of gharhar

transactions (e.g., selling the birds in the sky or the fish in the water, the catch of the diver, an unborn

calf in its mother's womb etc.). Jurists have sought many complete definitions of the term. They also

came up with the concept of yasir (minor risk); a financial transaction with a minor risk is deemed to be

halal (permissible) while trading in non-minor risk (bayu al-ghasar) is deemed to be haram.

What gharar is, exactly, was never fully decided upon by the Muslim jurists. This was mainly due to the

complication of having to decide what is and is not a minor risk. Derivatives instruments (such as stock

options) have only become common relatively recently. Some Islamic banks do provide brokerage

services for stock trading.

Microfinance

Microfinance is a key concern for Muslims states and recently Islamic banks also. Microfinance is

ideologically compatible with Islamic finance, capable of Shariah-compliancy, and possesses a sizeable

potential market. Islamic microfinance tools can enhance security of tenure and contribute to

transformation of lives of the poor. The use of interest found in conventional microfinance products and

services can easily be avoided by creating microfinance hybrids delivered on the basis of the Islamic

contracts of mudaraba, musharaka, and murabahah. Already, several microfinance institutions (MFIs)

such as FINCA Afghanistan have introduced Islamic-compliant financial instruments that accommodate

sharia criteria.

Controversy

In Islamabad, Pakistan, on June 16, 2004: Members of leading Islamist political party in Pakistan, the

Muttahida Majlis-e-Amal (MMA) party, staged a protest walkout from the National Assembly of Pakistan

against what they termed derogatory remarks by a minority member on interest banking:

Taking part in the budget debate, M.P. Bhindara, a minority MNA [Member of the National

Assembly]...referred to a decree by an Al-Azhar University's scholar that bank interest was not un-

Islamic. He said without interest the country could not get foreign loans and could not achieve the

desired progress. A pandemonium broke out in the house over his remarks as a number of MMA

members...rose from their seats in protest and tried to respond to Mr Bhindara's observations.

However, they were not allowed to speak on a point of order that led to their walkout.... Later, the

opposition members were persuaded by a team of ministers...to return to the house...the government

team accepted the right of the MMA to respond to the minority member's remarks.... Sahibzada Fazal

Karim said the Council of Islamic ideology had decreed that interest in all its forms was haram in an

Islamic society. Hence, he said, no member had the right to negate this settled issue.

Some Islamic banks charge for the time value of money, the common economic definition of Interest

(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, for example) to

apply to the use of money instead of the more accepted application of supplying goods or services using

money as a vehicle. A fixed fee is added to the amount of the loan that must be paid to the bank

regardless if the loan generates a return on investment or not. The reasoning is that if the amount owed

does not change over time, it is profit and not interest and therefore acceptable under Sharia.

Islamic banks are also criticized by some for not applying the principle of Mudarabah in an acceptable

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 in the Muslim community,

these banks may be conforming to the strict legal interpretations of Sharia but avoid recognizing the

intent that made the law necessary in the first place.

The majority of Islamic banking clients are found in the Gulf states and in developed countries. With 60%

of Muslims living in poverty, Islamic banking is of little benefit to the general population. The majority of

financial institutions that offer Islamic banking services are majority owned by Non-Muslims. With

Muslims working within these organizations being employed in the marketing of these services and

having little input into the actual day to day management, the veracity of these institutions and their

services are viewed with suspicion. One Malaysian 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 non Muslim.[44] These types of stories contribute to the general impression within the

Muslim populace that Islamic banking is simply another means for banks to increase profits through

growth of deposits and that only the rich derive benefits from implementation of Islamic Banking

principles.

Hence, the controversy that surrounds Islamic Banking continues. Is Islamic Banking really Islamic? This

is a question that still is a matter of debate among the Muslim academia.

References:

[1] Rammal, H. G. and Zurbruegg, R. (2007). Awareness of Islamic Banking Products Among

Muslims: The Case of Australia. Journal of Financial Services Marketing, 12(1), 65-74.

[2] Saeed, A. (1996). "Islamic Banking and Interest: A Study of the Prohibition of Riba and its

Contemporary Interpretation". Leiden, Netherlands: E.J.Brill.

[3] Subhi Y. Labib (1969), "Capitalism in Medieval Islam", The Journal of Economic History 29 (1), p.

79-96 [81, 83, 85, 90, 93, 96].

[4] Jairus Banaji (2007), "Islam, the Mediterranean and the rise of capitalism", Historical

Materialism 15 (1), pp. 47–74, Brill Publishers.

[5] Robert Sabatino Lopez, Irving Woodworth Raymond, Olivia Remie Constable (2001), Medieval

Trade in the Mediterranean World: Illustrative Documents, Columbia University Press, ISBN 0-231-

12357-4.

[6] Timur Kuran (2005), "The Absence of the Corporation in Islamic Law: Origins and Persistence",

American Journal of Comparative Law 53, pp. 785–834 [798–9].

[7] Subhi Y. Labib (1969), "Capitalism in Medieval Islam", The Journal of Economic History 29 (1), pp.

79–96 [92–3].

[8] Said Amir Arjomand (1999), "The Law, Agency, and Policy in Medieval Islamic Society:

Development of the Institutions of Learning from the Tenth to the Fifteenth Century", Comparative

Studies in Society and History 41, pp. 263–93. Cambridge University Press.

[9] Samir Amin (1978), "The Arab Nation: Some Conclusions and Problems", MERIP Reports 68, pp.

3–14 [8, 13].

[10] (Badr 1989, p. 424)

[11] 4.1 Historical development (http:/ / users. bart. nl/ ~abdul/ chap4. html)

[12] http:/ / www. usc. edu/ dept/ MSA/ economics/ islamic_banking. html

[13] Warde, I. (2000). "Islamic Finance In The Global Economy". Edinburgh: Edinburgh University

Press.

[14] http:/ / www. imf. org/ external/ pubs/ ft/ wp/ 2008/ wp0816. pdf Islamic Banks and Financial

Stability: An Empirical Analysis pg. 5 [15] "Sharia calling" (http:/ / www. economist. com/ world/ europe/

displaystory. cfm?story_id=14859353). The Economist. 2009-11-12. . [16] Slater, Joanna (2007-01-10).

"World's Assets Hit Record Value Of $140 Trillion" (http:/ / online. wsj. com/ article/

SB116839213664272112. html). The Wall Street Journal. .

[17] http:/ / www. iran-daily. com/ 1388/ 12/ 11/ MainPaper/ 3630/ Page/ 5/ Index. htm

[18] Lorenzo Totaro (2009-03-04). "Vatican Says Islamic Finance May Help Western Banks in Crisis"

(http:/ / www. bloomberg. com/ apps/ news?pid=20601092& sid=aOsOLE8uiNOg& refer=italy).

Bloomberg L.P.. . Retrieved 2009-04-13.

[19] http:/ / iran-daily. com/ 1386/ 2860/ html/ focus. htm

[20] http:/ / www. payvand. com/ news/ 09/ nov/ 1122. html

[21] http:/ / www. zawya. com/ Story. cfm/ sidZAWYA20091211065734/ Iran%202nd%20in

%20Islamic%20Banking%20Assets%20

[22] http:/ / www. presstv. com/ detail. aspx?id=104662& sectionid=351020102

[23] http:/ / www. presstv. com/ detail. aspx?id=117077& sectionid=351020102

[24] http:/ / www. radicalmiddleway. co. uk/ topics/ finance/ top-500-islamic-financial-institutions

[25] http:/ / in. bsi. ir/ default. aspx?scn=News-Details& & news_dtid=e75d2324-fb20-4edb-b14a-

7c4ef2bd2677& lid=c845e22d-2f63-49fc-9b4b-855986b2af20& mln=News_DetailPage

[26] http:/ / www. thebanker. com/ news/ fullstory. php/ aid/ 6129/

Iran_dominates_sharia_ranking_as_newcomers_make_their_mark. html

[27] http:/ / top500islamic. thebanker. com/ index. cfm?fuseaction=top500. home& CFID=1277573&

CFTOKEN=93128769

[28] http:/ / faculty. capebretonu. ca/ mchoudhu/ money. htm

[29] http:/ / web. archive. org/ web/ 20070716151628/ http:/ / www. islamibankbd. com/ page/

ih_12. htm

[30] Gabriel Rozenberg, Nobel prizewinner using micro-credit for macro benefit (http:/ / business.

timesonline. co. uk/ tol/ business/ markets/ china/ article755694. ece), The Times, December 16, 2006.

[31] Zeeshan Hasan, The Redefinition of Islamic Economics (http:/ / web. archive. org/ web/

20080404224903/ http:/ / www. geocities. com/ zeeshanhasan/ economics. html), The Daily Star,

August 27th, 1994.

[32] http:/ / zakatpages. com/ 2007/ 01/ 19/ alhamdulillah-for-lloyds-tsb-bank/

[33] World Database for Islamic Banking and Finance (http:/ / www. wdibf. com/ )

[34] Mervyn K. Lewis, Latifa M. Algaoud: Islamic Banking Cheltenham, 2001

[35] http:/ / www. badralislami. com/ glossary/ a-h. asp

[36] http:/ / www. azmilaw. com/ Article/ Article_8_& _9/ Article_9_Tawarruq_00093603_. pdf

[37] Nomani, Farhad; Rahnema, Ali. (1994). Islamic Economic Systems. New Jersey: Zed books

limited. pp. 99–101. ISBN 1-85649-058-0.

[38] "Learn more about Islamic Banking - Returns on deposits are competitive" (http:/ / www.

rhbislamicbank. com. my/ index. asp?fuseaction=learning. details& recID=77). RHB Banking Group.

2006-05-17. . Retrieved 2009-03-26.

[39] http:/ / www. irfi. org/ articles/ articles_301_350/ is_islamic_banking_islamic. htm

[40] http:/ / www. isda. org/ media/ press/ 2010/ press030110. html

[41] http:/ / www. irti. org/ irj/ go/ km/ docs/ documents/ IDBDevelopments/ Internet/ English/ IRTI/

CM/ downloads/ IES_Articles/

Vol%207-1%20and%202%20. . %20Sami%20Al-Suwailem. . Measure%20of%20Gharar. . dp. pdf

[42] http:/ / www. ruf. rice. edu/ ~elgamal/ files/ gharar. pdf

[43] Sait, 2006, p.175

[44] http:/ / www. dawn. com/ 2004/ 06/ 17/ top2. htm

Financial planning key to Islamic banking growth (http:/ / www. alfalahconsulting. com/ 2011/ 04/

financial-planning-key-to-islamic. html)

• Sait, Siraj; Lim, Hilary (2006). Land, Law and Islam. New York: UN-HABITAT.

Further reading

• Financial planning key to Islamic banking growth (http:/ / www. alfalahconsulting. com/ 2011/

04/ financial-planning-key-to-islamic. html)

• How Islamic Finance and Investments work and availability in the US and Canada (http:/ /

ijaraloans. com)

• Partnership, Equity-Financing and Islamic Finance: Whither Profit-Loss Sharing? (http:/ / papers.

ssrn. com/ sol3/ papers. cfm?abstract_id=1415239) by Dr. Mohammad Omar Farooq

• Historic Judgment on Interest Given by the Supreme Court of Pakistan (http:/ / albalagh. net/

Islamic_economics/ riba_judgement. shtml)

• Guide to Islamic Banking (http:/ / www. meezanbank. com/ guide_islamicbanking. aspx)

• Mufti Taqi Usmani's book on Islamic Finance (http:/ / www. darululoomkhi. edu. pk/ fiqh/

islamicfinance/ islamicfinance. html)

• Islamic Banking references (GDRC) (http:/ / www. gdrc. org/ icm/ islamic-banking. html)

• Risk & Compliance Management in Islamic Banking (http:/ / www. infosys. com/ finacle/ pdf/

thoughtpapers/ Risk-Compliance-Islamic-Banking. pdf)

• Bringing morality into finance (http:/ / www. latrobe. edu. au/ news/ articles/ 2009/ opinion/

bringing-morality-into-finance) - an opinion piece by Dr. Hayat Khan of La Trobe University

• Mahlknecht, Michael (2009). Islamic Capital Markets and Risk Management. London: Risk Books.

ISBN 978-1-906348-17-5.

• Encyclopedia of Islamic Finance, by Dr Aly Khorshid, published by Euromoney PLC, July 2009

• Islamic Finance as a Progenitor of Venture Capital, by Benedikt Koehler in: Economic Affairs,

December 2009

• Rosly, Saiful Azhar (2006). Critical Issues on Islamic Banking and Financial Markets: Islamic

Economics,

Banking and Finance, Investments, Takaful and Financial Planning. AuthorHouse. ISBN 978-1420837377.

External Links

• Fundamentals of Islamic Banking (http:/ / www. islamicbankingedu. com)

• Global Islamic finance news and information (http:/ / www. global-islamic-finance. com)

• Islamic Economics and Finance (http:/ / www. financialislam. com/ islamic-economics--finance.

html)

• World Database for Islamic Banking and Finance (http:/ / www. wdibf. com)

• Islamic Banks and Financial Institutions Information (http:/ / www. ibisonline. net/ )

• Islamic Financial Services Board (http:/ / www. ifsb. org/ )

• AIBIM - Association of Islamic Banking Institutions Malaysia (http:/ / www. aibim. com/ )

• Islamic Finance at Deloitte (http:/ / www. islamicfinance. deloitte. com/ )

• Accounting and Auditing Organization for Islamic Financial Institutions (http:/ / www. aaoifi.

com)

• Reviewing Islamic Banking (http:/ / www. iguides. org/ articles/ articles/ 15/ 1/ Reviewing-

Islamic-Banking/ Page1. html)

• Muslim Investor: A community site on Islamic investment, banking, finance and insurance (http:/

/ muslim-investor. com/ )

• Riba and Islamic Banking (http:/ / www. hazariba. com/ RibaNIB. shtml)

• Institute of Islamic Banking (http:/ / www. islamic-banking. com)

• Islamic Banking / Finance / Takaful Directory (http:/ / www. halalstock. com/ hban. asp?P=10)

• Islamic Banks Directory (http:/ / www. islamicbankingzone. com/ islamic-banking-finance-

directory/ )

• Neighborhood Development Center / First Reba-Free Financing program in the US (http:/ /

www. ndc-mn. org/ programs-services/ small-business-lending-reba-free-financing)