What is Islamic Banking?
Islamic banking is a system of conducting business activities in line with the principles of Islamic Shari'a'. It follows the rules and provisions of Islamic jurisprudence pertaining to trade and business, so-called fiqhal muamalat (Islamic rules on transactions). The Quran,Sunnah and other sources of Islamic law such as Ijma' (opinions collectively agreed among Shari'a scholars), Qiyas (analogy) and Ijtehad (personal reasoning) collectively form the basis, from which rules and practices of fiqhal muamalat (Islamic jurisprudence) are derived. Islamic banking avoids all the prohibited activities such as riba (usury-interest), gharar (uncertainty), financing of haram (forbidden) trades & businesses like alcoholic beverages, pornography, gambling, etc.
Is the Islamic bank a profit-making organization?
Islamic bank is a profit-making organization, where, the founders who invested their savings in establishing the bank entity and paid up the capital are looking for profits and return that conform and consistent with the rules and provisions of the Islamic Shari'a. The objective of investment and achieving profits is in line with Islamic Shari'a guidelines, whilst, hoarding money without investment is repugnant to Shari'a tenets and precepts, and deprives the economy from producing services and products. Thus, generating profit is one of the Islamic financial institutions objectives, yet, in accordance with the Islamic Shari'a principles.Furthermore,Islamic banks have other important objectives in the society such as, the social responsibility and presenting microfinance products (providing credit to the entrepreneurial poor).
What is the difference between the interest (usury) and the profit?
To understand the difference between profit and interest we should have an idea about definitions and pillars of contract according with the Islamic Jurisprudence. Islamic jurisprudence contracts or Transactions Fiqh contracts are the agreements that organize and manage people rights and obligations for exchanging money, trade and services among them. The contract comprises of three basic pillars, 1) the parties; 2) offer and acceptance between the parties; and 3) subject matter of the contract. Our concern here is the subject of contract, for instance, if I bought a vehicle from its seller the subject of the contract would be the vehicle which provided by the seller and the price provided by me whether it's in deferred payments or on spot, so the subject matter is the considerations given from each party to another.
Hence, in interest-bearing banking or the conventional banking, all its products ultimately are loans despite of its different titles i.e. personal loan, vehicle loan, and overdraft. etc., well, what is the subject matter of these products? What are the considerations in conventional banking products? The subject is money against money, in this situation the money became a commodity not a mean, in additions, the conventional bank shall not grant money without advantages! Absolutely not, the bank will give you money against increment (interest) over the principal amount represented by the deferred repayments, this is what so-called usury. Let's revert to the foregoing vehicle example above, assume that a customer approaches the conventional bank and applies for vehicle loan, the conventional bank doesn't buy the car from the supplier and owns the title and possess it by Shari'a-compliant contract, it just credit the car price to the customer account, and the customer pays deferred repayments or may send the car's price to the supplier account instead of crediting the price into the customer's account but not through a contract, here the subject matter of the product the money against money with increment which is the prohibited usury. Some conventional banks pay the amount directly to the vehicle dealer & mortgage it, register it and bring it to the customer just to facilitate the procedures for the customers or to mitigate its risk at times, but not for purpose of acquiring the car's title legally or from Shari'a perspective.
Concerning profit which is generated from process of selling; sale is permitted in Quran and Sunnah. Sale is needed by default to achieve the welfare and human well-being, and to meet the indispensable needs of people, the Quranic verse no. 275 in Al-Baqarah says "الَّذِينَ يَأْكُلُونَ الرِّبَا لاَ يَقُومُونَ إِلاَّ كَمَا يَقُومُ الَّذِي يَتَخَبَّطُهُ الشَّيْطَانُ مِنَ الْمَسِّ ذَلِكَ بِأَنَّهُمْ قَالُواْ إِنَّمَا الْبَيْعُ مِثْلُ الرِّبَا وَأَحَلَّ اللّهُ الْبَيْعَ وَحَرَّمَ الرِّبَا فَمَن جَاءهُ مَوْعِظَةٌ مِّن رَّبِّهِ فَانتَهَىَ فَلَهُ مَا سَلَفَ وَأَمْرُهُ إِلَى اللّهِ وَمَنْ عَادَ فَأُوْلَـئِكَ أَصْحَابُ النَّارِ هُمْ فِيهَا خَالِدُونَ the interpretation of the verse as follows: "As for those who devour interest, they behave as the one whom Satan has confounded with his touch. Seized in this state they say: "Buying and selling is but a kind of interest," even though Allah has made buying and selling lawful, and interest unlawful. Hence, he who receives this admonition from his Lord, and then gives up (dealing in interest), may keep his previous gains, and it will be for Allah to judge him. As for those who revert to it, they are the people of the Fire, and in it shall they abide". As well Verse no. 198 in surah Al-Baqarahلَيْسَ عَلَيْكُمْ جُنَاحٌ أَن تَبْتَغُواْ فَضْلاً مِّن رَّبِّكُمْ interpreted as: "It is no offence for you to seek the bounty of your Lord" bounty means in this verse the profit generated from the sale.
What is the difference between Islamic and non-Islamic banking?
The basic difference between Islamic banking and conventional banking is that Islamic Banking based on principles of Shari'a. Thus all aspects of a transaction like products' features, business approach, and investment focus are derived from the Shari'a law, which lead to a significant difference with those of the conventional banks especially in terms of risk and reward parity.
Islamic banking is not based on pricing money and earning interest as conventional interest-based banks do, but it is a system of trade where goods and services are sold and capital is invested by taking risk to earn halal profits. It is also not just a change of name as many miss-understood it to be, but it is based on the Quranic injunction whereby trade has been permitted and riba has been prohibited.
Amongst the governing principles of an Islamic bank are?
- The absence of interest-based (Riba) transactions
- The avoidance of economic activities involving oppression (Dhulm)
- The avoidance of economic activities involving speculation (Gharar)
- The avoidance of speculative activities (Qimar)
- The discouragement of the production of goods and services which contradict the injunctions of Islam (Haram)
What is the Sale?
It is a sale of a commodity against specific price agreed on between two parties. And the valid sale contract requires three pillars; the parties, offer and acceptance and the subject matter of the contract. The subject matter must be known, specific and owned by the seller when concluding the sale contract. And upon signing the vehicle Murabaha sale contract in the Islamic bank, the subject matter then is the car from the bank and the repayments from the customer. In additions, the car should be available upon signing the contract. The contract also, should contain the price and mode of payments.
What is the Murabaha Sale for the purchase orderer or promissor?
There are many types of sale in the Islamic jurisprudence, Murabaha sale is one of those types. And it is categorized underbiua' alamanat, in which the seller should inform the buyer about the actual cost of the commodity or the asset, in additions to the profit that will be added to the cost. The profit may be either a percentage from the principal or an amount according to the agreement between the parties. In Murabaha Sale, the price might be deferred in future installments.
In the Murabaha Sale, Bank shall be the seller and the customer is the buyer, where the customer promises Bank by purchasing the commodity in a certain date with a certain price as agreed. Based on the customer's promise, Bank shall purchase the commodity from the supplier and sale it on Murabaha basis to the customer. This contract is Shari'a-compliant and applied in all Islamic banks. By way of Murabaha sale Bank can finance cars, vehicles, lands, assets and properties.
What is the Mudharaba?
Mudharaba is one of the investment partnerships forms, and it is a profit and loss sharing mode of financing. In mudharaba, Bank in its capacity as the investor (capital provider) shall finance the customer (entrepreneur) in certain project after submitting a feasibility study by the latter according to its business field, in which, it shall anticipate certain profits for the project, and the profit percentages shall be pre-determined between the two parties. If loss happens due to a reason beyond the Mudarib (entrepreneur) capability, and not due to its negligence or misconduct, losses suffered shall be borne by Bank (the capital provider).
The principle of Mudharaba can be applied to Islamic Banking operations in two ways: between the bank (as the entrepreneur) and the capital provider, like the relationship between the bank and the depositor in the saving accounts, where the bank invests the deposited funds based on Mudharaba agreement, and between a bank (as capital provider) and the entrepreneur as explained in the first paragraph above.
What is the deposit in Islamic banking?
Unlike the conventional bank that grants certain interest and agreed upon in advance for the deposits and saving accounts. The Islamic bank invests the deposits on the unrestricted Mudaraba basis, where it invests it in the common pool in its capacity as Mudarib and investor. The Mudaraba contract must state that the profit shall be shared between the parties in certain percentages in advance. The term deposits duration must be determined and it could be 3, 6, 9 and 12 months, and at the maturity, the bankcalculates the net profit after deducting the expenses and distributes the profit between itself and the customers from a hand, and among the customers themselves from the other hand.
What is the Musharaka (Partnership)?
A partnership between two parties or more in a project/business with the objective of achieving profit, or to acquire an asset. The realized profit shall be shared between the partners according to their percentage in the capital on pro rata basis or as agreed on between the parties. However, losses incurred will be shared only based on the ratio of funds invested by each partner.
Bank enters into Musharaka agreement (partnership) with the customer based on the feasibility study presented by the customer in his/her business field. In light of the conducted business beforehand, the customer shall give an anticipated percentage of profit that achieved in similar business. At the maturity of the investment period, the profits shall be shared as per the capital ratio or as agreed on.
What is the Diminishing Musharaka?
This contract is used for project/asset financing, Bank will enter into a Diminishing Musharaka Agreement with the Customer, whereby, thebank and the customer shall acquire an asset jointly, in accordance with Sharikat-ul-milk tenets. Each party shall contribute into the Musharaka asset with a certain percentage. Bank and the customer's common shares towards the Musharaka asset shall be reflected and divided into the Musharaka Units,and shall be set out in an Annexure annexed to the Musharaka Agreement. Bank shall assign the customer the right to purchase the asset from the Seller, and shall be responsible to ensure the specifications and all matters relating to the asset are duly met.
Moreover, the customer may register the asset's title under his/her name as a Managing Partner, along with his/her responsibilities in procuring the structural maintenance, handling insurance and paying any required levy or taxes.
Further, any revamps or additions to the asset shall be done under the customer's supervision and responsibility.The customer shall incrementally acquire parts of bank's Musharka Units from time to time at the face value. Accordingly, at the maturity of the Musharka, the title of Bank's share in the asset shall transfer to the customer, thereupon; the customer shall be deemed the owner of the asset solely.
The customer shall lease bank's Musharaka share against certain Rentals payments; consequently, the customer shall occupy and use the entire Musharaka' asset.M
What is Lease (Ijarah)?
Ijarah is a contract of purchasing a specific usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets and wage in case of hiring of persons.
What is Lease ends with title transfer (Ijarah w Iqtnaa)?
It is one of the modes of financing applied in the Islamic banks for properties and assets, pursuant to the Ijarah contract the customer promises Bank by leasing a specific asset, accordingly Bank purchases the asset from its seller and lease it to the customer. The rentals consist of two elements, fixed element and variable element, the fixed element meets the original cost of the asset, while the variable element represents the rent or return that the customer pays against utilizing the asset. The rentals and contract duration are determined as per the parties' agreement. Bank in this regard is the owner of the asset till the maturity.
What is Istisna'a?
It is a contract to finance manufacturing assets or commodities, thereon, the price can be paid in advance and the asset or commodities delivery postponed until being manufactured or made. Postponement of the price and the asset is possible too according to some scholars; among other types of sales, this is allowed only in Istisna'a sale contract.
This contract is used in the Islamic banks to finance assets and commodities as well, where Bank in its capacity as a seller or "Al Sane'" shall construct the asset according to the agreed certain specifications and drawings, and deliver it in a certain date.The customer in its capacity as a buyer (Mustasnea) shall pay the price in installments.
What is Salam Sale?
Unlike the rest of sale contracts, in Salam sale contract, the price should be paid in advance and commodity delivery is postponed. It is a forward contract with immediate price. While the other sale contractsrequire the existence of the commodity at the time of contracting except the Istisna'a contract.So Salam is an exception to this rule. Provided that the asset should be identified, prescribed accurately, delivery date is specified, and the seller is capable to deliver it. The advance price is one of the Salam sale contract conditions. The Islamic banks use the Salam sale in financing the agriculture and all commodities that can be duly specified.
What is Letter of Credits (LC)?
LCs is one of the important banking services that extended by the banks to the customers. Where it is considered the fundamental of the trade (export and import) through the corresponding banks network worldwide.
It is a request by the customer to settle the imported goods' price, where the bank settles through the corresponding banks the commodity's price by the required currency.
It is executed in banks via two modes:
A) Carrying out the LC as a banking service, in which the goods cost paid by the customer, and the bank's role is to procure the banking procedures to open the LC and settle the value in the required currency with the corresponding bank. In this mode the bank takes a commission from the customer against offering its services.
B) Carrying out the LC as a financing, where the bank pays the goods' value to the beneficiary in additions to handling the required procedures. In Islamic banking LC can be financed by several modes of financing such as Murabaha or Mudaraba.
How do Islamic Credit Cards work?
Credit cards have become a modern mean to spend instead of carrying money, due to its high security, convenient usage and its acceptance from outlets internationally. And these cards are used to settle purchases prices at POS and to shop online. Islamic banks however, have developedmany Shari'a solutions to issue credit cards instead of the interest-bearing cards of conventional banking. One of those solutions is granting the card's limit to the customer as an interest-free loan (Qard- Hassan), and not taking interest against the usage of the this limit. In turn, as the card grants the customer a bunch of services, benefits and privileges, the bank charges an administrative fee against the service extended to the customers. This fee should not exceed the actual cost of the service.
What is Agency (Wakala)?
Wakala is appointing an agent to perform a specific task or investing fund against a percentage from the capital or a certain agreed amount. Islamic banks apply the Wakala in many forms, where the bank may appoint the customer to invest its fund in a specific project after submitting a feasibility study from the customer expecting therein achieving a certain percentage of profits.
Whilst, the bank pays a percentage from the capital or an amount as agreed between the two parties.
The Wakala product can be used when the customer deposits funds with the bank. The latter invests it in a specific project or in the common pool against a certain profit.