Evolution of Islamic banking in the world and the privileges it offers. Explain and illustrate in the worldwide aspect.

 Abstract

Islamic banking is the process of banking that is consistent with the Islamic law. Islamic banking doesn’t deal in interest. It is prohibited for Muslims to earn, pay, witness or deal with interest in any way. In many parts of the Holy Quran and Hadith, it is mentioned that interest- and the conventional banking system- is haram. Other than that, there are several other issues of Islamic banking. For example, banks are not allowed to invest in businesses that are prohibited (e.g. sale of alcohol). Rather, Islamic banks thrive under the notion of profit-sharing. Islamic banking brings the issue of fairness. If the bank pays for an investment initially, should it also get a taste of the loss made? Hence, Islamic banking divides the burden and reward among parties. Quite ironically, the origin of Islamic banking is not very old. The first case of Islamic banking came in Egypt in 1963. The boom occurred in 1980s. Today Islamic banking is still on the rise. It has gained popularity among the non-Muslims too. Obviously there are many benefits of Islamic banking. The chief benefit is that it ensures fair play. It promises the rights of the lenders as well as the borrowers. To many, it is the answer to the many of the world’s economic solutions.

Table of Contents

Introduction ………………………………………………………………… 1

Concepts, Terminologies and Principles of Islamic Banking.…………….. .2

Islamic Banking in the Light of Holy Quran and Hadi…….……………… 5

Privileges of Islamic Banking……………………………………………… 7

Evolution of Islamic Banking ……………………………………………… 9

Conclusion …………………………………………………………………. 12

References

Introduction

Muslims boast that theirs is a religion that is not technically a “religion” at all: it’s a way of life. Being a Muslim, as it turns out, is a major lifestyle choice. Islam is not limited to a set of rituals and worships that promise heaven and God’s gratification in the life hereafter. It also gives precise guidelines on how to lead one’s life.

It has laws in every aspect of life. Business and finance is also covered in Islam. Islamic banking, as I have explained later, is a banking system that is interest-free and totally Sharia compliant.

In a world filled with “Islamophobia” (!), Islamic banking is actually on the rise, mainly in the developed world.

This report explains why this is so the privileges of Islamic banking. It sheds lights on the evolution of Islamic banking worldwide and how its current trends.

Concepts, Terminologies and Principles of Islamic Banking

To understand the benefits of Islamic banking and its evolution, we first we need to know the major notions of Islamic banking.

Definition of Islamic Banking

Islamic banking is based on Shariah(Islamic law) and prohibits in dealing with interest. It is defined as “banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Ribaa or usury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic principles is also Haraam (forbidden).”[1]

The terminologies may be divided into three parts: financing, leasing and investing.

Investment

Mudaaraba: This involves two parties starting a partnership where one gives the money and the other provides the expertise and other resources such as time. Profits are shared in a predetermined proportion however any losses which occur are the responsibility of the bank.

Mushaaraka: Mushaaraka is partnership. Here, capital is shared between more than one parties and therefore risk and reward are also shared. The difference between Mushaaraka arrangements and conventional banking is that the business partner can set any type of profit sharing ratio, but losses must be proportionate to the amount invested. Under this arrangement a bank joins a commercial enterprise in founding a joint venture, where they partake in predetermined proportions. Both profits and losses are shared in a prearranged manner.

Muraabaha: This is a contract for purchase and resale and permits the customer to make purchases without having to take out a loan and pay interest. For example, a bank purchases a car for the customer, and re-sells it to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the car over installments, thus obtaining credit without paying interest.

 Financing

Muraabaha: This is referred as a contract for purchase and resale and allows the consumer to make purchases without having to apply for loan and give interest. For example, the bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin (called mark-up). The customer then pays the sale price for the goods over installments, effectively obtaining credit without paying interest.

Qard hasanah: This is when we have a loan without interest. Only the amount that is borrowed is paid back. He/she may pay an additional amount at his absolute judgment as a symbol of appreciation. An Islamic bank can use this as a current account, allowing customers to keep money (or receive payment, or carry out any type of money transfer) in the bank without earning interest.

Ijaara: Ijaara means lease or rent. It involves a contract where the bank buys and then leases an item – perhaps a consumer durable, for example – to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance. The bank retains ownership of the item throughout the arrangement and may take back the item at the end.

Istisnaa’: This is a contractual agreement for manufacturing goods and commodities. It facilitates advance cash payment and future delivery or a future payment, and future delivery. Istisnaa’ can be used for providing the facility of financing the manufacture or construction of houses, plants, projects, and building of bridges, roads, and highways etc.

 Islamic insurance

Takaaful: Takaaful can be claimed to be Islamic insurance. Here, the majority guarantees the loss of the minority (i.e. the majority shares the burden of the unfortunate minority through the accumulation of funds). It is one kind of co-operative insurance. Takaaful is a substitute form of cover that a Muslim can use against the jeopardy of loss due to misfortunes.

Wadiah: In this arrangement of safekeeping, bank is assumed as a keeper and trustee of funds. A client deposits funds in the bank and the bank promises refund of the entire sum of the deposit, or any part of the outstanding amount, whenever the depositor asks for it.

Banking in the Light of Holy Quran and Hadith

 

Transactions that deal in interest are unlawful in Islam; banking that involves interest is strictly forbidden. Many of the conventional banking laws are shunned upon in the light of Islam. There are several verses in the holy Quran and authentic Hadith that reflects this.

“Those who feed on usury will only rise again (on the last day), like those possessed by the devil. They say in effect, usury and selling is the same thing, whereas God permits selling but forbids usury… God will reduce interest to dust while making alms fruitful…O you believers, fear God, and renounce the excess of usurious interest, if you really believe. If you do not follow this ruling, you may expect the hostility of God and of his Messenger. If you repent, you will retain your capital, neither harming anyone else nor suffering harm yourselves. To a debtor in difficulty, grant a delay until his situation improves. And if you renounce your rights that will be better still.” [Quran 2:275-280]

 

Not just in the Holy Quran, prohibition of interest is also mentioned in the Hadith:

 

The Messenger of Allah (pbuh) said, “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts; and any increase is Ribaa.” [Muslim]

 

While the above says that “the increase is Ribaa”, the following quotation says who is sinful in the whole process of dealing with interest:

 

 He (pbuh) cursed the one who takes Ribaa, the one who pays it, the one who witnesses it, and the one who documents it. He then said, “They are all equal (in sin).” [Muslim]

 

Hence, a “good” Muslim strives to avoid conventional banking. Dealing in the conventional banking system is therefore unlawful in Islam.

 Privileges of Islamic Banking

The biggest privilege- and the most important- a Muslim earns from avoiding conventional banking system and using Islamic banking is of course, his reward in the life hereafter. However, he also gets many financial benefits in this world too.

In Islamic banking, the burden is not thrown to the entrepreneur. Rather, it becomes a profit sharing project. This process is very fair and just compared to when the bank, even though gives its own money, is not liable for any loss.

“One of the unique and salient characteristics of Islamic banks is that the integration of ethical and moral values with its banking operation. The ethical and moral consideration of Islamic banks cannot be detached and their behavior should be consistent with the moral and ethical standards laid down by the Islamic Shari’ah.

Unlike the conventional banks, the financing of Islamic banks are restricted to useful goods and services and refrain from financing alcoholic beverages and tobacco or morally unacceptable services such as casinos and pornography, irrespective of whether or not such goods and services are legal or not in a given country.”[2]

“Another important characteristic which forms the basis for the development of Islamic banks is the relationship with depositors. They deal with their customers on investment grounds rather than a pre-determined fixed interest rate. They invest the money of their depositors on high profitable projects after going through a strategic analysis in order to give a substantial return to their depositors.

Thus in Islamic banking industry, each bank will attempt to out-perform other banks if it wants to attract funds from investors. And the ultimate result is that a high return on investments for the investors, which is unlikely in a conventional bank where it deals with their depositors on a pre-determined fixed interest rate.

Furthermore Islamic banks eliminate the barrier between those who save and those who invest, and bring them closer to the real market. The nature of the financial intermediation of Islamic banks significantly defers from conventional banks and it is in harmony with real market and developmental changes in it.”[3]

Evolution and Current Condition of Islamic Banking

Recent years have seen the rise of Islamic banking worldwide. The origin of proper Islamic banking doesn’t go very far away. “First instance of Islamic banking came into the picture in Egypt in 1963. The pioneering efforts by Ahmad El Najjar brought this bank into existence, whose key principle was profit sharing (non-interest based philosophy of Shariah). By the end of 1976 there were 9 such banks in the country. These banks neither charged nor paid interest but their activities were mostly limited to trade and industries where these banks invested directly or as partners of depositors. Hence, functionally these banks were working more as financial institutions rather commercial banks.”

The real boom in Islamic banking occurred in 1980s. Earlier, Islamic banking only focused on interest-free banking; it didn’t cover other major issues such as property rights etc which falls under this kind of banking system. “The new, wider spectrum of Islamic finance covers not only banking activities but also capital markets, capital formation and other financial instruments and intermediaries.” [4]

Today, Islamic banking is not just found in Islamic countries, but are popular in secular states as well as in those country where the majority is non-Muslims.

 Assets that conform under Islamic law reached about $400 billion across the globe in 2009, (with Iran, Malaysia and Saudi Arabia being the major contributors) according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion.

“In 2009 Iranian banks accounted for about 40 percent of total assets of the world’s top 100 Islamic banks. Bank Melli Iran, with assets of $45.5 billion came first, followed by Saudi Arabia’s Al Rajhi Bank, Bank Mellat with $39.7 billion and Bank Saderat Iran with $39.3 billion. Iran holds the world’s largest level of Islamic finance assets valued at $235.3bn which is more than double the next country in the ranking with $92bn. Six out of ten top Islamic banks in the world are Iranian. In November 2010, The Banker published its latest authoritative list of the Top 500 Islamic Finance Institutions with Iran topping the list. Seven out of ten top Islamic banks in the world are Iranian according to the list.” wikipedia

Conclusion

Earning, paying, witnessing or dealing with interest is strictly forbidden under Islamic law. Even a few decades ago Islamic banking did not provide the comfort and sophistication conventional banking provided. However, the past decade or so has seen a rise in Islamic banking, thus making the whole process of Islamic banking more available and affordable. It is indeed good news for the Muslim community worldwide that Islamic banking has gained popularity in recent times.

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