Driven by Belief: Islamic Banking
Do you know this form of banking frowns upon Interest collection against loans?
Do you know about a banking system that works on a partnership model with its customers?
Well, it is none other than, Islamic Banking, a system that traces its roots to the Sharia Law!
Ready to know more about Islamic banking?
Islamic Banking
Islamic banking follows the Sharia principles, prohibiting interest and promoting ethical finance. It offers alternative financial products like profit-sharing arrangements and partnerships. Transactions must adhere to Sharia rules, avoid forbidden industries, and aim for fairness and social responsibility.
Let us know about the base of Islamic Banking!
Islamic finance
Islamic finance is banking that follows Islamic law (Sharia). Unlike regular banks, it avoids interest (Riba). Instead, it focuses on partnerships where the bank and customer share profits and risks in a business deal. Sharia also discourages things like gambling and risky bets (Gharar, Maysir). So, it’s all about ethical financial partnerships with a clear purpose and fair risk-sharing.
We’ve uncovered the bedrock, now it’s time to travel back in time and see where it all began!
Origin
Despite being a nascent industry in market terms, this system has roots dating back centuries. With a banking history spanning over 400 years, it works according to the moral principles drawn from sources such as the Quran, Hadith, Ijma, and Qiyas.
Islamic banking originated for several reasons:
- Religious Compliance: It emerged to align banking practices with Islamic principles outlined in Sharia law, which prohibit interest (riba) and promote ethical finance.
- Ethical Finance: Islamic banking aims to provide financial services that adhere to principles of fairness, justice, and societal welfare, avoiding industries considered harmful or unethical.
- Financial Inclusion: It seeks to cater to the financial needs of Muslim communities worldwide, ensuring they have access to banking services that align with their religious beliefs.
- Alternative Model: It offers an alternative to conventional banking systems, providing avenues for investment and financing that prioritize risk-sharing and partnership arrangements over interest-based transactions.
Ahem!
Eager to know how Islamic banking works in action?
Let’s look at a real-time example!
Real-time example
Consider You Want to Buy a House
- Finding Your Dream Home: You find a house you love listed for £200,000.
- Approaching the Islamic Bank: You discuss your situation with the bank, explaining your desire for a Sharia-compliant home purchase.
- Murabaha Agreement: The bank might choose a Murabaha agreement. They would buy the house for the listed price (£200,000).
- Profit Discussion: You and the bank agree on a profit margin for the bank, say £20,000. The total price you’ll repay becomes £220,000.
- Instalment Plan & Ownership: The bank sets up a repayment plan for you to pay back the £220,000 over a set term (e.g., 25 years). As you make payments, you gradually own a larger portion of the house.
Essentially, instead of a traditional mortgage with interest, the bank acts as a partner by purchasing the house. You then buy it from them with a pre-determined profit included in the price. This profit-sharing adheres to Sharia principles. Over time, you own the house outright.
Hmmm…
You had a close-up look at Islamic banking!
We have given you a microscopic view of Islamic banking! Now, let’s see how it differs from conventional banking in various aspects.
Conventional Vs Islamic Banking
Well, we’re not halting here!
Onward to the Big Fish!
The Guardians
An independent body called the Internal Shariah Supervisory Committee (ISSC) oversees the bank’s Shariah compliance. Their key responsibilities include:
- Reviewing all aspects of the Bank’s operations: This encompasses business activities, products, services, contracts, documents, and even the bank’s code of conduct. Essentially, the ISSC ensures everything aligns with Shariah principles.
- Issuing binding Shariah rulings: The ISSC has the authority to issue fatwa (legal pronouncements) and resolutions that the bank must follow to remain Shariah-compliant.
- Monitoring ongoing compliance: The ISSC doesn’t just set the guidelines; they also monitor the bank’s adherence through the Internal control division and internal audits.
Albeit!
After all’s said and done, Islamic banking throws its hat into the ring of risks too!
Risks of Islamic Banking
- Sharia Compliance: Products may not always adhere to Sharia’s principles post-implementation.
- Displaced Commercial: Returns on Profit-Sharing Investment (PSI) accounts may vary from conventional commercial banking.
- Business Model: Difficulty in managing liquidity due to limited Shariah-compliant financial markets
- Complex Transactions: Requirements for transactions to be asset-backed result in intricate corporate structures, involving non-financial corporations.
Okay, It's time for a curtain call!
Must Know
Open to All Faiths: Don’t be fooled by the name!
Islamic banking products and services are available to everyone.
Summary
- Money as a Medium: Islamic finance views money as a tool for buying and selling things with real value, not something valuable itself.
- No Interest: Earning money solely from lending (interest) is discouraged. The focus is on shared benefits through trade or investment.
- Ethical Investing: Islamic finance avoids activities considered harmful, like those involving alcohol, tobacco, or gambling.
- Risk and Reward Sharing: Islamic finance promotes partnerships where both profits and risks are shared between parties involved in a transaction.
Islamic Banking is interesting, but the Global payment ecosystem holds so many more systems like these waiting for us to discover.
Until then, happy reading!
P.S: What topic do you think we should explore next? Let us know in the comments.
