Introduction to Islamic Banking
Islam is not only a religion in the ordinary sense of the word, but a complete system of life. While other religious codes provide guidance only for the relation between man and his Creator, Islam guides man in his relationship with God, and gives him the norms which govern his temporal existence, since Islam is concerned with the spiritual, political, social economic, moral and all other material aspects of the human being.
Every social system has its own economic system. Islam being a comprehensive and distinct social system, possesses a corresponding economic system of its own. Islamic economics is fast developing into a different and distinct paradigm of economics. Therefore, a number of Islamic financial institutions have emerged in various Muslim as well as some non-Muslim countries reaching finally at long last to our country Kenya. Hence the development of Islamic or interest free banking in the region.
Difference between Islamic and conventional banks
There are a number of key differences between the products and services offered by a conventional bank in comparison to an Islamic financial institution.
Firstly, Islam is the back bone of interest free banking, moral principles and objectives play a more important role in its operations. As such it is organized on the basis of cooperation with each other as stated in the Quranic injunction: "Help you one another in righteousness and piety but help you not one another in sin and transgression (Quran, 5:2). The Quran also calls for trade "Eat not up your property among yourselves in vanities but let there be amongst you, traffic and trade by mutual goodwill"(Quran, 4:29). Honesty and trustworthiness is so essential in business, thus the Prophet (Pbuh) had declared that dishonest transactions are illegal (reported by Bukhari).
Secondly, no gain is accepted without either effort or liability. Islam forbids receiving a monetary advantage without giving a counter value, but is not opposed to profit or financial gain as long as an effort is performed or (partial) liability is accepted for the financial result of a venture.
Thirdly, general conditions of a debtor should be evaluated genuinely. If one is in financial distress, and is not able to pay back the principal, one should be given an extension on humanitarian ground without any penalty. (Quran, 2:280)
Fourthly, certain business transactions are considered unlawful in Islam and cannot be carried out in an Islamic bank. For example trading in alcohol, intoxicating drugs, gambling or producing pornography are contrary to Islam.
Fifthly, Islamic banks offer no interest-bearing products or services, and in its organisational structure and corporate governance, Islamic banks have Shariah board, to ensure that the bank practices are in conformity with the Shariah and do not oppress the disadvantaged client.
Prohibition of Riba in the Quran and Sunnah
What is Riba?
It is the addition of premium paid to the lender in return for the waiting period as a condition for the loan. Riba has the same meaning and import as interest in accordance with the consensus of all fuqaha (jurists) and is haram. The following are the steps on Riba prohibition:
First stage of prohibition of Riba
Says God: "That which you give as interest to increase the peoples wealth increases not with God; but that which you give in charity, seeking the pleasure of God, multiplies manifold". (Quran, 30:39)
Second stage of prohibition
Say God: "For the wrong doing of Jews, we made unlawful for them certain good foods which had been lawful for them - and for their hindering many from God's way. And their taking of Riba"(usury) though they were forbidden from taking it. (Quran, 4:160-161)
Third stage of prohibition
Says God: "O you who believe: Eat not Riba (usury) doubled and multiplied, and fear God that you may be successful. (Quran, 3:130)
Fourth and final stage of prohibition
Says God: "O you who believe! Be conscious of Allah and give up what remains (due to you) from Riba (usury) (from now onward), if you are (really) believers. And if you do not do it, then take a notice of war from Allah and his Messenger, but if you repent you shall have your capital sums. Deal not unjustly (by asking more than your capital sums) and you shall not be dealt unjustly (by receiving less than your capital sums). (Q 2:278 – 279).
Prohibition of Riba in the Sunnah
Reported by Jabir bin Abdullah that the Prophet (Pbuh) said: "Cursed is the receiver and the payer of interest, the one who records it and the two witnesses to the transaction". And he said: "They are all alike". (Muslim)
Islamic Banking In Practice
Islamic banks operate various types of transactions the most important of which are:
I. Collection of Deposit
Since interest bearing deposits entail Riba, Islamic banks offer two different kinds of deposits.
- Current account
- Investment account
Current account: The deposited capital is guaranteed and made available to the client on demand. No reward is paid on the deposit but is mainly used for transactions and safety keeping.
Investment account: Deposits remain with the bank for a certain previously agreed period. Customers open investment account to yield financial return based on trust financing. The depositor is the financing partner, while the managing partner is the bank.
II. Financing contracts
1. Murabaha (mark-up sale)
It comes from the Arabic word 'ribh' which means profit (short –term trade financing). Murabaha is selling a commodity as per the purchasing price with a defined and agreed profit mark-up. This mark-up may be a percentage of the selling price or a lump sum. Murabaha financing differs from a conventional financing, as it involves the financing of physical assets. The bank shares in the risk of ownership. Rather than simply advancing money to a client, the bank itself buys the goods from a third party on request of a customer. The bank then sells it to the customer for a pre-agreed price through a deferred payment scheme, usually in the form of installments.
2. Musharaka (profits and loss sharing system)
It is an agreement between two persons or more (bank and customer) sharing both profits and losses.
Islamic bank vs Conventional bank
Conventional banks have fixed rate of returns; while Musharaka, base their returns on the actual profits made. Conventional banks as opposed to Islamic ones do not share losses nor do they take such risks. Conventional banks have no interest on how the business is run; while in Musharaka the Islamic bank is directly involved in the proper functioning of the business.
Types of Musharaka partnerships
There are many types of Musharaka ranging from traditional types of partnerships to modern corporations. Musharaka could either be:
Permanent musharaka: An Islamic bank participates in the equity of a project and receives a share of the profit on a prorata basis. The time length of the contract is specified, making it suitable for financing projects where funds are committed over a long period.
Diminishing musharaka: This allows equity participation and sharing of profits on a prorata basis, and provides a method through which the bank keeps on reducing its equity in the project, ultimately transferring ownership of the asset to the customer. The contract provides for payment over and above the bank's share in the profit for the equity held by the bank. Simultaneously the entrepreneur purchases some of the banks equity, progressively reducing it until the bank has no equity and thus ceases to be a partner.
It is a partnership in profit whereby one party provides capital (rab al-maal-the bank) and the other party provides the know how/labour (Mudharib). The bank contributes 100% of the capital. Profits are shared on an agreed ratio. If there is any loss the bank takes 100% responsibility unless there was a case of misconduct, negligence or breech of contract on the part of Mudharib.
4.Ijara contract (leasing) or Ijara Muntahia bi at-tamleek (lease ending in property ownership
Ijara: Is the same as leasing thus leasing practised in interest – free banks is similar to its conventional practice. During the life of the asset, the risk of ownership remains with the bank, while the lessee is liable for misuse of the asset.
Ijara Muntahia bi at-tamleek (lease ending in property ownership)
This is a form of leasing contract, which includes a promise by the lesser to transfer the ownership of the leased property to the lessee. Example, the bank purchases the asset say a house. The client rents it from the bank, as he enters into an agreement to buy the shares from the bank over an agreed time frame. He then buys out small shares from the bank from time to time ending up with 100% ownership.
5. Bay'us-Salam (Advance purchase)
Advance payment for goods which are to be delivered at a specified future date. Under normal circumstances, a sale cannot be effected unless the goods are in existence at the time of the bargain. However, this type of sale is an exception, provided the goods are defined and the date of delivery is fixed. The objects of sale must be tangible goods that can be defined as to the quantity, quality and workmanship.
Islamic banking and finance are a part of Islamic economic system, the basis of which revolves around justice and morality. It is a very young concept in modern times yet it is emerging as one of the fastest growing areas of international finance. It facilitates the uplifting of economic standards of its clients by providing various types of lending contracts. Above all it is Shari'ah compliant, hence protects a Muslim from dealing with Riba, thus avoiding Allah's wrath and war. Let us all support Islamic banking venture, which is being provided by the establishment of Gulf African Bank. We pray and believe that the bank will strictly stick to Islamic principles and Shari'ah and uplift the living standards of all those who endeavour to do so in a decent manner – Amin.