Principles of Islamic banking
Islamic banking aims to fulfil the objectives of Sharīah laws which are mainly derived from the primary sources such as the Qur’ān, Ḥadīth and the consensus of religious scholars. Islamic banking tries to balance profit maximisation with social, religious and ethical obligations by avoiding ribā (usury) and conducting each transaction with honesty, sincerity credibility and transparency. Along with these elements, the presence of a Sharīah board and advisors differentiate Islamic banks from conventional banks.
|
Characteristics |
Islamic Banking System |
Conventional Banking System |
|
Guiding principle |
Guided by Qur'anic, Hadīth, Islamic ethics and Islamic laws. |
Guided by profit motive alone, with no religious or expressly ethical considerations. |
|
Ethics of financing and involvement of risk |
Financing to be used for productive use. Risk-sharing and profit sharing go together. |
Debt burden arising out of excessive use of credit leads to bankruptcies and waste of financial resources. Conventional banks carry much less risk, the major part of the risk being transferred to the borrowers. |
|
Return on capital |
Depends on productivity: idle money cannot earn any return. |
Even idle money in bank deposits earns returns. |
|
Prohibition of Gharar (uncertainty)
|
The existence of uncertainty in a contract is prohibited. “Full disclosure” by both parties is the norm in contracts. |
Trading and dealing in derivatives are widely considered as the main source of liquidity in the conventional financial, commodity and capital markets. |
|
Zakât |
Islamic banks collect and distribute Zakāt – one of the five pillars of Islam where a Muslim deducts 2.5% from their capital and distributes it to poor every year |
Government taxes, mode and rate of charging are different |
|
Interest on interest |
The Islamic banks have no provision to charge any extra money from defaulters. |
May charge additional money (compound rate of interest) in the event of default. |
|
Relationship with customers |
The status of the Islamic bank in relation to its customer is that of partners, investors and/or trader. |
The status of a conventional bank, in relation to its customers, is that of creditor and/or debtor. |
The overwhelming principle of an Islamic banking system is the prohibition of Ribā (usury). An Arabic word, Ribā is mentioned eight times in Qur’ān and refers to any excess or extra (price, weight, quality) in relation to time. The challenge to the Islamic bank is to profit while at the same time sharing the risk as a partner of the customer.
Any authentic Islamic banking transaction requires absence of Gharar (ambiguity and uncertainty in quantity of the object, price and time of payment in sale). There is also a prohibition on gains made from games of chance (lotteries, betting, gambling), trade of alcoholic beverages, pork, tobacco and defence and all activities that are ethically objectionable in Islam.
In Islamic banking, fixed and certain increases of money are deemed to create greediness, selfishness, idleness, injustice, unproductivity, lack of sympathy and inefficiency – in other words, Ribā (usury) is banned. But that is not to say the element of risk is absent from Islamic financial transactions on the part of the borrower. This makes the Islamic banking system different from an interest-based system where usury is charged on loans and the borrower has to pay interest and repay the capital, whether the borrower makes a profit or loss from the use of these funds.
Sharīʿah board in Islamic Banks
The concept of Sharīʿah consultation was started for the very first time in 1976 at Faisal Islamic bank of Egypt, which consisted of selected religious scholars from Egypt. After that, every Islamic bank must appoint one or more Sharīʿah scholars with the knowledge of fiqh muamlat (Sharīʿah transaction law) to ensure that the banking operations and documentation of products are according to the rules of Sharīʿah.
The main role and responsibilities of a Sharīʿah board are
- To certify, verify and issue a report that banking instruments, involvements and services are in accordance to Islamic law.
- To achieve a consensus on difficult interpretation and implementation on new issues through fatwā (a legal opinion issued by a qualified Muslim scholar). This allows innovation and competence in approving new Sharīʿah products
- Calculation and payment of Zakāt and disposal of non-Sharīʿah compliant earnings
- To ensure that conventional banks which are introducing Islamic banking services through Islamic windows are managed in agreement with Islamic values.
Our next report will examine the various techniques and product designs used to satisfy Islamic Banking requirements.
| Corporate Social Responsibility in Banking A Guide to Global Best Practice |
| Publishing January 2012 |
