What is Islamic banking?

And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other peoples' property. We have prepared for those among who reject faith a grievous punishment. (Surah al-Nisa', verse 4:161) Islamic banking is defined as banking system which is in compliance with the spirits, beliefs and values of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and un-social practices. In practical sense, Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic prosperity. What are the basic principles of Islamic banking? The basic principles of Islamic banking are: 1. 2. 3. 4. 5. 6. Prohibition of Interest. Risk sharing. Prohibition of speculative behaviour. Involved on Sharia approved activities only. Involved in real economic sector only. Sanctity of contract.

What are the benefits of Islamic banking? Generally, the Islamic Bank will benefit the users by having Sharia Compliant Banking products and services; these benefits include lawful profits for deposits as a result of halal investments as well as lawful channels and structures of different business deals. Moreover, the users will have the peace of mind dealing with the bank that follows full Shariah principles, avoid unethical and anti-social practices. What is the difference between conventional banking and Islamic banking? CONVENTIONAL BANKING ISLAMIC BANKING Money is a commodity besides medium of Money is not a commodity though it is used as a exchange and store of value. Therefore, it can be medium of exchange and store of value. Therefore, sold at a price higher than its face value and it can it cannot be sold at a price higher than its face also be rented out. value or rented out Time value is the basis for charging interest on Profit on trade of goods or charging on providing capital. service is the basis for earning profit Interest is charged even in case the organization Islamic bank operates on the basis of profit and suffers losses by using banks funds. Therefore, it is loss sharing. In case, the businessman has suffered not based on profit and loss sharing. losses, the bank will share these losses based on the mode of finance used (Mudharaba, Musharakah). 1

While disbursing cash finance, running finance or The execution of agreements for the exchange of working capital finance, no agreement for exchange goods & services is a must, while disbursing funds of goods & services is made. under Murabaha, Salam & Istisnaa contracts. Conventional banks use money as a commodity Islamic banking tends to create link with the real which leads to inflation. sectors of the economic system by using trade related activities. Since, the money is linked with the real assets therefore it contributes directly in the economic development.

What is the purpose of Amana Bank providing Islamic Banking services? The main purpose of Amana Bank is to provide its target market with competitive financial solutions, alternative banking services which comply with Sharia principles in a manner that is beneficial to all stakeholders i.e. our customers, our shareholders, our employees, our suppliers and government. Apart from you, are there other full-fledged Islamic Banks? There are more than 200 Full-fledged Islamic Banks around the world as well as more than 300 conventional banks offering Islamic banking products and services i.e. Africa, Asia, Europe, North America. The first Islamic Bank was established in 1973 in UAE. Do we really need Islamic Banking? In order to assess the need of the bank, we need to look at the functions it performs. In any society, be it a secular or Islamic one, the main function of the bank is to mobilize funds from the surplus units and allocate these to the shortfall units or to the units having budget constraints. This function is performed through the process of financial intermediation in the financial markets where banks are the most important operators. Financial intermediation enhances the efficiency of the saving/investment process by eliminating the mismatches inherent in the requirements and availability of financial resources of savers and entrepreneurs in an economy. Normally the surplus units/savers are the small households or individuals who save relatively small amounts whereas the entrepreneurs are firms which often need relatively large amounts of funds. Financial intermediation removes this size mismatch by collecting the small savings and packaging them to suit the needs of entrepreneurs. In addition, entrepreneurs may require funds for periods relatively longer than would suit individual savers. Intermediaries resolve this mismatch of maturity and liquidity preferences again by pooling small funds. Moreover, the risk appetite of savers and entrepreneurs are also different. It is often considered that small savers are risk averse and prefer safer placements whereas entrepreneurs may wish to deploy funds even in risky projects. The role of the intermediary again becomes crucial. They can substantially reduce their own risks through the different techniques of proper risk assessment and risk management. Furthermore, small savers cannot efficiently gather information about opportunities to place their funds. Financial intermediaries are in a much better position to collect such information which is crucial for making a successful placement of funds. The role and functions of banks outlined above are indeed highly useful and socially desirable. Hence, we reach to the point where the banks become the need of any economy so is Islamic Banking. 2

More important, is the ability of Islamic Banking in spreading the risk evenly among key players in a manner that avoids exploitation, unethical as well as anti-social practices through the use of partnership contracts and trade based contracts.

Is Islamic banking meant only for Muslims? The teachings of Islam are not confined to Muslims; rather they equally address the non-Muslims due to their universal nature. The service basis of Islamic bank is laid down on ethical values and socially responsible system. The values like justice, mutual help, free consent and honesty on the part of the parties to a contract, avoiding fraud, misrepresentation and misstatement of facts and negation of injustice or exploitation form the basic principles of Islamic banking. Therefore, Islamic Bank serve both Muslim and non-Muslim clients who wants to place themselves on transparent, certain, clean and profitable deals. What is meant by Riba? The word Riba means excess, increase or addition. Under Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). For example, any paid excess to principal amount of a monetary loan is Riba. Why Riba prohibited in Islam? Apart from the clear Quranic injunction on the prohibition of riba (2:275-281),(3:130) there are other issues with riba which cause it to be prohibited. It is considered a form of injustice and exploitation, a source of income inequality, an incentive for speculation, attributing cause of economic malaise such as inflation and deflation and it promotes selfishness and greedy in society. Is Riba prohibited in Islam only? The following references against the prohibition of Riba/usury are drawn from the old testament of the bible: Deuteronomy 23:19: Thou shall not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything that is lent upon usury. Psalms 15:1, 2, 5: Lord, who shall abide in thy tabernacle? Who shall dwell in thy holy hill? He that walketh uprightly, and worketh righteousness and speaketh the truth in his heart He that putteth not out of his money to usury, nor taketh reward against the innocent Proverbs 28:8: He that by usury and unjust gain increaseth his substance, he shall, gather it for him that will pity the poor. Nehemiah 5:7: Then I consulted with myself, and I rebuked the nobles, and rules and said unto them, Ye exact usury, every one of his brother. And I set a great assembly against them. Ezekiel 18:8.9: He that hath not given forth upon usury, neither hath taken any increase, that hath withdrawn his hand from iniguity, hath executed true judgment between man and man, hath walked in 3

my statues, and hath kept my judgments, to deal truly; he is just. He shall surely live, said the Lord God. Ezekiel 22:12: In thee have they taken gifts to shed blood; thou hast taken usury and increase, and though hast greedily gained of thy neighbours by extortion, and hast forgotten me, said the Lord God. In these excerpts of the Bible the word usury is used in the sense of any amount claimed by the creditor over and above the principal advanced by him to the debtor. In Hinduism. Among the oldest known references to usury are to be found in ancient Indian religious manuscripts and Jain (1929) provides an excellent summary of these in his work on Indigenous Banking in India. The earliest such record derives from the Vedic texts of Ancient India (2,000-1,400 BC) in which the usurer (kusidin) is mentioned several times and interpreted as any lender at interest. More frequent and detailed references to interest payment are to be found in the later Sutra texts (700-100 BC), as well as the Buddhist Jatakas (600-400 BC). It is during this latter period that the first sentiments of contempt for usury are exressed. For example, Vasishtha, a well known Hindu law-maker of that time, made a special law which forbade the higher castes of Brahmanas (priests) and Kshatriyas (warriors) from being usurers or lenders at interest. Also, in the Jatakas, usury is referred to in a demeaning manner: hypocritical ascetics are accused of practising it. In Ancient Western Philosophy. Among the Ancient Western philosophers who condemned usury can be named Plato, Aristotle, the two Catos, Cicero, Seneca and Plutarch (Birnie, 1958). Evidence that these sentiments found their concurrent manifestation in the civil law of that period can be seen, for example, from the Lex Genucia reforms in Republican Rome (340 BC) which outlawed interest altogether. In Modern Reformist Thinking. Some may be surprised to discover that Adam Smith, despite his image as the Father of the Freemarket Capitalism and his general advocacy of laissez-fair economics, came out strongly in support of controlling usury (Jadlow, 1977; Levy, 1987). While he opposed a complete prohibition of interest, he was in favour of the imposition of an interest rate ceiling. This, he felt, would ensure that low-risk borrowers who were likely to undertake socially beneficial investments were not deprived of funds as a result of the greater part of the money which was to be lent *being+ lent to prodigals and projectors [investors in risky, speculative ventures], who alone would be willing to give [an unregulated] high interest rate (Smith, 1937: 339). The great twentieth century economist John Maynard Keynes held a similar position believing that the disquisitions of the schoolmen [on usury] were directed towards elucidation of a formula which should allow the schedule of the marginal efficiency to be high, whilst using rule and custom and the moral law to keep down the rate of interest, so that a wise Government is concerned to curb it by statute and custom and even by invoking the sanctions of the Moral Law (1936: 351-3). Another less well known anti-usury economic reformist was Silvio Gesell (1904), yet Keynes wrote that the world could learn more from him than from Marx. Gesell, as a successful nineteenth century merchant in Germany and Argentina, condemned interest on the basis that his sales were more often 4

related to the price of money (i.e. interest) than peoples needs or the quality of his products. His proposal of making money a public service subject to a use fee led to widespread experimentation in Austria, France, Germany, Spain Switzerland, and the United States under the banner of the so-called stamp script movement, but these initiatives were all squashed when their success began to threaten the national banking monopolies (Kennedy, 1995). Margrit Kennedy (1995), a German professor at the University of Hannover, is one of the most vocal contemporary critics of interest who builds on Gesells ideas, believing that interest acts like cancer in our social structure. She takes up the cause for interest and inflation-free money by suggesting a modification of banking practice to incorporate a circulation fee on money, acting somewhat like a negative interest rate mechanism. Finally, another school of modern interest critics have their roots in the complementary work of several socio-economic reformists of the early twentieth century, namely Douglas (1924), Fisher (1935), Simons (1948) and Soddy (1926). Their chief common premise was that it is completely wrong and unacceptable for commercial banks to hold a monopoly on the money or credit creation process. For banks to then charge interest (including to government) on money which they had in the first place created out of nothing, having suffered no opportunity cost or sacrifice, amounted to nothing less than immoral and fraudulent practice. Various alternative systems are proposed by the original authors and carried forward by their modern-day torch-bearers, for example, the Social Credit Secretariat and the Committee on Monetary and Economic Reform. Is there a difference between Riba and interest/usury? The origination of term interest dates back to 17th century with the emergence of banking system at global level. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning/value as that of Riba as defined in the previous question. Further, it is narrated that the loan that draws interest is Riba. Does interest relate only to consumption loans or it applies to commercial loans also? The interest is prohibited in Islam regardless the amount or the purpose of the loan. It is prohibited whether it is consumption loan (loan for meeting day to day human needs) or commercial loan (loan for business purpose). What is the difference between interest and trade profit? Interest is the excess of the principal amount of loan while trade profit is the income available as a result of business undertaking, the interest is normally pre-rated excess and fixed amount tied up to the face value while trade profit is pro-rated amount accrued to the fund invested. If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers? The Islamic Bank uses depositors funds and its funds in various trades; investment and service related Shariah compliant activities and earns profit thereupon. The profit earned from such activities is passed on to the depositors according to the agreed terms. 5

Are Islamic banks just paying interest and dressing it as profit on trade and Investments? No, Islamic Bank accepts the deposits either on profit and loss sharing basis or on Qard basis. These deposits are deployed in financing, trading or investment activities by using the Shariah compliant modes of finance. The profit so earned by the bank is passed on to the depositors according to the preagreed ratio which, therefore, cannot be termed as interest. Is it permissible to charge a fee for any late or partial payments? If so, is this acceptable under the Sharia? Yes, it permissible to charge fee for both service provision and late payment on the dues as a penalty. This undertaking is in fact a sort of oath which is a self-imposed penalty during the signing of the contract to keep oneself away from default. It is self-imposed. This undertaking is acceptable under Islamic Shariah as it helps in reducing the risk on transaction. However, the money collected as penalty is not an income to the bank instead it is an amount to be spent in charity for the benefit of the community at large.