Banking on Sharia Principles

Sharia Principles

In order for Islamic banks to be competitive with conventional products and attractive to customers, Islamic financial products must meet the risk/reward profiles of investors and issuers while fulfilling the tenets of the Sharia and remaining sufficiently cost-effective. Additionally, Islamic banks must educate their personnel to understand the tenets of Islamic law that pertain to banking, and to train them to comply with Sharia as they serve their Islamic customer population

Banks that comply with Islamic law are forbidden to charge interest or late payment fees, which is also considered a type of riba. Another way that banks work within Islamic laws while trying to turn a profit is by buying an item that the customer wants, and then selling the item to the customer at a higher price.

An Islamic bank does not lend money to a borrower to buy properties; rather, the bank will purchase the property at the borrower’s request at a freely disclosed price, and mark up the price for the borrower to pay back, therefore making a profit from the investment. There are significant middle-class suburban and urban populations that already use conventional banking, and therefore present ripe opportunities for Islamic banks.

Musharakah is similar to Mudharabah, in which an entrepreneur seeks funds for a business venture and pays the bank back with a ratio of profits. There are often more than two parties who contribute funds and become partners who can influence the business depending on the amount of money invested.

 

Murabaha governs the issuing of home loans or any other type of goods needed by a borrower. An Islamic bank does not lend money to a borrower to buy properties; rather, the bank will purchase the property at the borrower’s request at a freely disclosed price, and mark up the price for the borrower to pay back, therefore making a profit from the investment. The borrower is named on the title and allowed to utilize the property immediately and pays the bank back in installments.

There are an estimated 1.61 billion Muslims worldwide, making Islamic banking one of the fastest growing segments of the financial industry. If they hope to retain existing customers and attract new ones, banks serving the Islamic population must comply with several very specific principles of Islamic law. Banks must be ready with specialized services and products and they must put programs in place to train their personnel to support these products and services in order to exist in this competitive marketplace.

While each Islamic bank has its own board which rules on ethical banking principals, Islamic banking organizations have been establishing standard regulations and policies. The Islamic Development Bank has been working on international standards, procedures and policies, and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic Finance Service Board (IFSB), International Islamic Financial Market, Liquidity Management Center and International Islamic Rating Agency are in development to ensure fair and accurate banking practices.

The basic principle of Islamic banking follows the laws of Sharia, known as Fiqh al-Muamalat (Islamic rules on transaction). The Islamic terminology for this is riba or ribaa. The Sharia also forbids engagement in investments that include financial unknowns such as buying and selling futures, as well as businesses that are haraam – dealing in products that are contrary to Islamic law and values such as alcohol, gossip, pork or pornography.

According to Standard and Poor’s surveys, 20% of the customers in the Gulf Area and Southeast Asia would choose an Islamic banking product over a similar conventional product. There are significant middle-class suburban and urban populations that already use conventional banking, and therefore present ripe opportunities for Islamic banks. Most important to note, outside of the political and religious allure of Islamic banks, is that people are choosing their services for the safeties they offer.

Banks serving the Islamic population must comply with several very specific principles of Islamic law if they hope to retain existing customers and attract new ones. The basic principle of Islamic banking follows the laws of Sharia, known as Fiqh al-Muamalat (Islamic rules on transaction). Another way that banks work within Islamic laws while trying to turn a profit is by buying an item that the customer wants, and then selling the item to the customer at a higher price.

 

The bank rewards the amount of time the depositor keeps the money in the bank with a hibah or gift, which is not guaranteed. The hibah is similar to interest, but lawful according the Islamic law.

The Mudharabah is a partnership between the bank and an entrepreneur. The bank is known as the rabal-maal and the entrepreneur as the mudarib. The bank provides all of the necessary capital to start the entrepreneur and a business does the work of managing the business.

Another type of loan is the Ijara, in which the bank buys the home or item and leases the property to the borrower while retaining ownership of the property. The borrower can either use the property for a pre-determined period of time, or pay off the purchase price and buy out the Bank to attain full ownership of the property.

In 1975 there was one Islamic bank; today there are over 300 in more than 75 countries. Islamic banks have become more prevalent worldwide and can be found in high numbers in such countries as Indonesia, Pakistan, Bangladesh, Nigeria, Egypt, Turkey, Iran, Sudan, Algeria, Morocco, Iraq, Uzbekistan, Afghanistan, Malaysia, Saudi Arabia, Yemen, Syria and Kazakhstan.

There are occasionally controversies surrounding the interpretation of the riba, which certain scholars argue was meant to prevent petty money-lenders from abusing borrowers, rather than a modern bank charging a reasonable, agreed upon interest. The general consensus, however, is that any interest is a direct violation of the law of Sharia and therefore unethical.

It's only fair to share...Share on FacebookShare on Google+Tweet about this on TwitterShare on LinkedInShare on RedditDigg this