Islamic BankingIslamic Banking

INTRODUCTION INTRODUCTION Islamic banking is interest free banking, in which there is no fixed rate of return.

Islamic banking is guided by Islamic law ( Shari a`) 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.

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TERMINOLOGIES TERMINOLOGIES

Takaful (Islamic Insurance) is a co-operative system of reimbursement, paid to people and companies in case of hazards & misfortunes. It is compensated out of a fund to which they agree to donate small regular contributions.

MurabahaIt is a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest.

Bank purchases the goods on behalf of the customer, and re-sells them to the customer on an agreed profit margin and the customer pays the sale price for the goods over installments.

Riba and Gharar are illegal under Islamic law. Riba refers to fixed rate of interest. Gharar refers to speculation.

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Shariah ( Islamic Law)

Shariah means a way(or)path. In Islam Shariah refers to the divine

guidance and laws given by the Holy Quran, the sayings of the Prophet Muhammad along with interpretations given by Islamic Scholars.

Shariah embodies all aspects of the

Islamic faith, including beliefs and practices.

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Ijarah Ijara is a form of leasing.

It involves a contract where the bank buys and then leases an item.

For example: auto ijarah is simply an agreement under which the vehicle shall be given to you on rent for a period, agreed at the time of the contract. Bank purchases the vehicle and lease it out to the consumer for the agreed period.

MusharakaIt means partnership. It involves placing your capital with another person and sharing the risks and rewards in profit sharing ratio, but losses must be proportionate to the capital invested.

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PRINCIPLES OF PRINCIPLES OF ISLAMIC BANKING ISLAMIC BANKING

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Individual freedomIndividual freedom Every individual enjoys freedom of thought , speech & expression. Islam always cares about the freedom of life irrespective of gender, race & religion.

Social rightsIslam imposes social right over individual’s wealth in various forms, for example the rights of kindred, rights of neighbors, rights of the poor and spending in the way of Allah.

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Equitable distribution of Equitable distribution of income and wealthincome and wealthIt lays down certain regulations for the maintenance of equity such as distinction between lawful and unlawful means of income, right of free enterprise for individuals and right to keep the lawfully earned wealth

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Principle of the ultimate Principle of the ultimate ownership and the concept ownership and the concept of vicegerenceof vicegerence

Allah is the creator and ultimate owner to the universe. These principles ensure the banks will fulfill the responsibility of investing their own capital as well as others according to the syariah.

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Principle of integrating Principle of integrating every activity with the every activity with the morale valuemorale value

Ethical behaviors are one of the most important injunctions of the Islamic shariah. Islam does not only promote good ethical and moral behavior, it strongly prohibits unethical and immoral behaviors of all sorts.

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DIFFERENCE BETWEEN DIFFERENCE BETWEEN ISLAMIC BANKING & ISLAMIC BANKING & CONVENTIONAL BANKINGCONVENTIONAL BANKING

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Bank ClientGoods & Services

money

Islamic Banking System

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Bank Client

money

money + money (interest)

Conventional

Banking System

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Conventional BanksConventional Banks Islamic BanksIslamic BanksMoney is a commodity besides medium of Money is a commodity besides medium of exchange and store of valueexchange and store of value

Money is not a commodity thought it Money is not a commodity thought it is used as a medium of exchange and is used as a medium of exchange and store of valuestore of value

Time value is the basis for charging Time value is the basis for charging interest on capitalinterest on capital

Profit on trade of goods for charging Profit on trade of goods for charging on providing service is the basis for on providing service is the basis for earning profitearning profit

Interest is charged even in case the Interest is charged even in case the organization suffers losses by using organization suffers losses by using bank’s fundbank’s fund

Islamic bank operates on the basis of Islamic bank operates on the basis of profit and loss sharingprofit and loss sharing

While disbursing cash finance, running While disbursing cash finance, running finance or working capital, no agreement finance or working capital, no agreement for exchange of goods & services is made.for exchange of goods & services is made.

The execution of agreements for the The execution of agreements for the exchange of goods & services is a exchange of goods & services is a must while disbursing funds under must while disbursing funds under Murabaha, salam & Istisna contractsMurabaha, salam & Istisna contracts

Lending money and getting it back with Lending money and getting it back with compounding interest is the fundamental compounding interest is the fundamental functions of the conventional banksfunctions of the conventional banks

Compounding calculation is strictly Compounding calculation is strictly prohibited under Islamic banking prohibited under Islamic banking systemsystem

Nature of deposits in Islamic Banks

Mudarabah is a special kind of partnership where one partner providers the capital to the other for investment in a commercial enterprise.

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DepositDeposit NatureNature

CurrentCurrent QarzQarz

SavingSaving MudarabahMudarabah

ISLAMIC BANKING AS AN ISLAMIC BANKING AS AN ALTERNATIVE APPROACH ALTERNATIVE APPROACH

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For Muslims, this system of profit/loss sharing coincides with their belief in the prohibition of interest, and helps in mobilizing unused funds for investment and creating new job opportunities.

As for non-Muslims, the Islamic banking system does not contradict their faith, while it provides the society with alternative ideas for venture capital and other tools of investment.

Mudarabah as a contract of participation between

the provider of capital and the managing entrepreneur responds to normal human needs.

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The ultimate test of such alternative is whether it is successful or not. It can be safely said that the idea of Islamic banking has been successful.

Islamic banking was partially practiced by some of the Western banks and financial institutions in Switzerland, U.K. and the United States.

Economists have proven that the wider is the freedom of choice the higher is the level of social welfare. In addition, wider choice implies greater respect of human rights. When an alternative concept such as Islamic banking is introduced, a new choice is open to the market, with obvious economic and social benefits.

Introducing Islamic banking as a new choice has also further benefits related to the advantages it provides to many fund users.

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Commodity and service producers would certainly appreciate equal opportunities for obtaining capital based on the merits of their businesses rather than on their personal creditworthiness alone.

Those entrepreneurs who prefer to be self employed need ways to obtain financing other than borrowing. Islamic banking gives those pioneers such an opportunity on the basis of profit/loss sharing.

In general, Islamic finance places more weight on the merit of the business to be financed, rather than the wealth of the fund user. As a result under this new banking alternative, a better distribution of credit may be achieved.

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CHALLENGES AND CHALLENGES AND PROSPECTSPROSPECTS

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The biggest challenge Islamic banks have faced from their very beginning is how to narrow the gap between the Islamic banking model and its application; in other words, between theory and practice.

Difficulties come from being relatively small in a traditional banking environment, having to rely on bankers trained in traditional banking, and attempting to balance the unquenchable enthusiasm on the side of depositors, with a limited supply of investment opportunities.

Islamic banks have been trying hard to meet these

challenges through several means. The first is to work for a better understanding of the concepts upon which their operations are based. This has been a success to the extent that now traditional bankers are mostly cooperative and accommodating. 21

Another means is to train their staff in this new form of banking and to press for more banking and financial innovations which are necessary for the new modes of finance. Fortunately, financial engineering has come in handy with bold and new ideas in finance which made the Islamic model so much more applicable.

Surprisingly, financial markets produced some useful innovations, perhaps indicating that Islamic banking is an idea whose time has come. The prospects of Islamic banking and finance will depend extensively on the ability of Islamic banks to continue facing challenges with resourcefulness and creativity, in addition to being worthy of trust and understanding. I believe that competition, if allowed and maintained, not only within Islamic banks, but also between all banks whether Islamic or traditional, would insure a promising future for the banking industry as a whole.

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Submitted By:Group 8Submitted By:Group 81399 Bhavna Malik1398 Sarika Bidada621 Mansi Gaba519 Jyoti Chadha

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