Islamic banking

What is Islamic Banking?
Islamic banking is the product of the collective effort of bankers, economists and Islamic Sharia
scholars over the past several decades to develop financial solutions that meet the religious
requirements of Muslims in an ethical manner. It is an ethical and equitable mode of financial
services that derives its principles from the Sharia (Islamic law). The Sharia is based on the
Quran and the Sunnah of the Prophet Muhammad (PBUH), and it governs all aspects of
personal and collective life.

It is a young and growing industry that continues to evolve and expand both financially and
geographically. The Islamic banking industry today stands at over a trillion dollars and consists
of more than 400 financial institutions in and outside the Muslim world. It is indigenous and
community-focused: it caters to Muslims in predominant Muslim societies as well as in
Muslim minorities of non-Muslim countries. Furthermore, it is an inclusive paradigm: non-Muslim
individuals and communities that seek ethical financial solutions have also been attracted to
Islamic banking.

How is it dierent from conventional banking?
Islamic banking is a form of banking based on Islamic principles. Islamic principles do not allow
payment or receipt of Riba (interest). The concept of profit-and-loss sharing, as a basis of
financial transactions is a progressive one as it distinguishes good performance from the bad
and the mediocre, and encourages better resource management.

Therefore, the most distinctive element of Islamic banking is the prohibition of interest, whether
‘nominal’ or ‘excessive’, simple or compound, fixed or floating. Other elements include the
emphasis on equitable contracts, the linking of finance to productivity, the desirability of profit
sharing, based on Sharia compliant contracts and the prohibition of gambling and certain types
of uncertainty. These parameters define the nature and scope of Islamic banking, as interpreted
by the Sharia scholars that work with Islamic financial institutions. Islamic banks focus on
generating returns on investments through investment tools that are Sharia compliant.

Banking with a positive outlook
The outlook for Islamic banking remains positive despite the recent challenging global financial
environment. Its viability and competitiveness is derived from its ability to meet the changing
demands of the economy; from its cost competitiveness; from being supported by a welldeveloped
legal, regulatory and supervisory framework; and most importantly, the fundamental
Sharia requirements of Islamic finance that support its stability.
Islamic banking is a rapidly growing phenomenon in the global financial markets as it answers
the call of Muslims who seek a banking system that conforms to their religious tenets. Because
of this, a number of banks from all over the world oer products and services that are Sharia
compliant.

The finer points of Islamic Banking
Transactions
In Islamic banking all transactions are based on the principle that funds do not generate funds,
unless they are coupled with an activity or work. The functions and operating modes of Islamic
banks and their underlying transactions are based and approved on the principles of Islamic
Shari’a. Islamic banking promotes risk sharing between provider of capital (investor) and the
user of funds (entrepreneur). It also aims at maximizing profit but subject to Shariah
restrictions.

Public service-driven
Islamic banking gives due importance to the public interest. Its ultimate aim is to ensure growth
with equity.

Financing
Partnering new businesses is the fundamental function of the Islamic banks.
Islamic banking seeks to actively encourage entrepreneurs by funding small enterprises through
partnerships that end with ownership. Islamic banks place funds to other banks without taking
or giving interest.
What’s more, Islamic banks have no provision to charge any extra money from the defaulters.
In fact, only a nominal amount is levied by way of compensation and this money is donated to
charity. On the other hand, rebates may be given for early settlement at the Bank’s discretion.

Investment of funds
In Islamic banking, funds are invested only in lawful ventures that achieve social and economic
development. Areas prohibited by Sharia are strictly avoided.

Security
Since Islamic banking operates under the principle of profit and loss sharing, the banks pay
greater attention to developing project appraisal and evaluations. They give greater emphasis
on the viability of the projects. The status of Islamic banks in relation to their clients is that of
partners, investors, traders, buyers and sellers, based on Sharia structures such as Mudaraba,
Murabaha, Musharaka and Ijarah.