Islamic banking and finance: Difference between revisions

Browse history interactively ← Previous edit Next edit →Content deleted Content addedVisual WikitextInline

Revision as of 07:31, 13 November 2005 editZeno of Elea (talk \| contribs)3,238 editsmNo edit summary← Previous edit		Revision as of 08:07, 13 November 2005 edit undoGrenavitar (talk \| contribs)Extended confirmed users30,686 edits move to opposition section again, Zeno, don't swamp the intro. add something about it in a short blurb.Next edit →
Line 1:		Line 1:
	'''Islamic banking''' refers to a system of banking or banking activity which is consistent with ] (Sharia) principles and guided by ]. In particular, Islamic law prohibits the collection and payment of ], also commonly called '']'' in Islamic discourse. In addition, Islamic law prohibits investing in businesses that are considered ] (such as businesses that sell alcohol or pork, or businesses that produce un-Islamic media). In the late 20th century, a number of ''Islamic banks'' were created, to cater to this particular banking market.		'''Islamic banking''' refers to a system of banking or banking activity which is consistent with ] (Sharia) principles and guided by ]. In particular, Islamic law prohibits the collection and payment of ], also commonly called '']'' in Islamic discourse. In addition, Islamic law prohibits investing in businesses that are considered ] (such as businesses that sell alcohol or pork, or businesses that produce un-Islamic media). In the late 20th century, a number of ''Islamic banks'' were created, to cater to this particular banking market.

⚫	Some Muslims have opposed these Islamic banks, claiming that they do deal in interest but merely conceal it through legal tricks. Indeed, from an ] perspective, Islamic banks do compensate and charge for the ], thus paying and receiving what is known in economics as "interest." Such Muslims compare Islamic banking to ] - a legal trick devised by European bankers and merchants during the ], designed to facilitate the borrowing of money at a fixed rate of interest (something that the ] fiercely opposed) through combining three different contractual agreements which in and of themselves were not prohibited by the Church.
⚫
⚫	One form of the argument against interest is that money is not a good and profit should be earned on goods and services only, not on control of money itself. Economists, however, believe that interest is a natural phenomenon, and one can indeed see from an economic perspective that Islamic banking is based on interest banking, in the sense of compensating investors for the ] .

⚫	While Islamic law prohibits the collection of interest, it does allow a seller to resell an item at a higher price than it was bought for, as long as there are clearly two transactions.

	== Principles in Islamic Banking ==		== Principles in Islamic Banking ==
Line 68:		Line 62:

	This is a token given voluntarily by a debtor to a creditor in return for a loan. '''Hibah''' usually arises in practice when Islamic banks voluntarily pay their customers interest on savings account balances.		This is a token given voluntarily by a debtor to a creditor in return for a loan. '''Hibah''' usually arises in practice when Islamic banks voluntarily pay their customers interest on savings account balances.

			== Opposition ==

		⚫	Some Muslims have opposed these Islamic banks, claiming that they do deal in interest but merely conceal it through legal tricks. Indeed, from an ] perspective, Islamic banks do compensate and charge for the ], thus paying and receiving what is known in economics as "interest." Such Muslims compare Islamic banking to ] - a legal trick devised by European bankers and merchants during the ], designed to facilitate the borrowing of money at a fixed rate of interest (something that the ] fiercely opposed) through combining three different contractual agreements which in and of themselves were not prohibited by the Church.
		⚫
		⚫	One form of the argument against interest is that money is not a good and profit should be earned on goods and services only, not on control of money itself. Economists, however, believe that interest is a natural phenomenon, and one can indeed see from an economic perspective that Islamic banking is based on interest banking, in the sense of compensating investors for the ] .

		⚫	While Islamic law prohibits the collection of interest, it does allow a seller to resell an item at a higher price than it was bought for, as long as there are clearly two transactions.

	==See also==		==See also==

Revision as of 08:07, 13 November 2005

Islamic banking refers to a system of banking or banking activity which is consistent with Islamic law (Sharia) principles and guided by Islamic economics. In particular, Islamic law prohibits the collection and payment of interest, also commonly called riba in Islamic discourse. In addition, Islamic law prohibits investing in businesses that are considered haram (such as businesses that sell alcohol or pork, or businesses that produce un-Islamic media). In the late 20th century, a number of Islamic banks were created, to cater to this particular banking market.

Principles in Islamic Banking

Islamic banking has the same purpose as conventional banking except that it claims to operate in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba´ (interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah) and leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. This higher cost represents the bank charging the debtor in order to compensate for the time value of money; in other words, this higher cost is exactly the essence of interest. However, the fact that it is interest cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the property itself remains under the ownership of the bank until the mortgage is paid in full (in the event of a default, the property remains under the bank's ownership and may be sold by the bank). This arrangement is called Murabaha. Another approach is Ijara wa Iqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

In business deals, there are several other approaches to implicitly compensating for the time value of money. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank, so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, as it is Allah who determines that failure, and intends that it fall on all those involved.

Last, but not least, Islamic banking is restricted to Islamically acceptable deals, which exclude those involving alcohol, pork, gambling, etc. Thus ethical investing is the only acceptable form of investment, and moral purchasing is encouraged.

Islamic banks have grown recently in the Muslim world but are a very small share of the global economy compared to the Western debt banking paradigm. Micro-lending institutions such as Grameen Bank use conventional lending practices, and are popular in some Muslim nations, but are clearly not Islamic banking.

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to establish Shariah advisory committees/ consultants to advise them and to ensure that the operations and activities of the bank comply with Shariah principles.

In Malaysia, the National Syariah Advisory Council additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Shariah aspects of the operations of these institutions, as well as on their products and services. (See: Islamic banking in Malaysia)

Concepts In Islamic Banking

Wadiah (Safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with a 'hibah' (gift) as a form of appreciation for the use of funds by the bank. In this case, the bank compensates depositors for the time-value of their money (i.e. pays interest) but refers to it as a "gift" because it does not officially guarantee payment of the gift.

Mudharabah (Profit Sharing)

Mudharabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity. Any profits made will be shared between the capital provider and the entrepreneur according to an agreed ratio, where both parties share in profits and only capital provider bears all the losses if occurred. The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating-point interest rate that is pegged to the debtor's profits.

Musharakah (Joint Venture)

This concept is normally applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio, while losses incurred will be divided based on the equity participation ratio. This concept is distinct from fixed-income investing (i.e. issuance of loans).

Murabahah (Cost Plus)

This concept refers to the sale of goods at a price, which includes a profit margin agreed to by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a vehicle), with a fixed rate of interest determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e. the bank cannot charge additional interest on late payments), however the asset remains in the ownership of the bank until the loan is paid in full.

This type of transaction is similar to "rent-to-own" arrangements for furniture or appliances that are very common in North American stores.

Bai' Bithaman Ajil (Deferred Payment Sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except that the debtor makes only a single installment, on the maturity date of the loan.

Wakalah (Agency)

This occurs when a person appoints a representative to undertake transactions on his/their behalf, similar to a power of attorney.

Qardhul Hassan (Benevolent Loan)

This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not violate the prohibition on riba, since it is the one type of loan that truly does not compensate the creditor for the time value of money .

Ijarah Thumma Al Bai' (Hire Purchase)

There are two contracts involved in this concept. The first contract, Ijarah contract (leasing/renting) and the second contract, Bai' contract (purchase) are undertaken one after the other. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed rental over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price. In effect, the bank sells the product to the debtor, at an above market-price profit margin, in return for agreeing to receive the payment over a period of time; the profit margin is equivalent to interest earned at a fixed rate of return. This type of transaction is particularly reminiscent of contractum trinius, a complicated legal trick used by European bankers and merchants during the Middle Ages, which involved combining three individually legal contracts in order to produce a transaction of an interest bearing loan (something that the Church made illegal).

Bai' al-Inah (Sell and Buy Back Agreement)

The financier sells an asset to the customer on a deferred payment basis and then the asset is immediately repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency.

Hibah (Gift)

This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah usually arises in practice when Islamic banks voluntarily pay their customers interest on savings account balances.

Opposition

Some Muslims have opposed these Islamic banks, claiming that they do deal in interest but merely conceal it through legal tricks. Indeed, from an economic perspective, Islamic banks do compensate and charge for the time value of money, thus paying and receiving what is known in economics as "interest." Such Muslims compare Islamic banking to contractum trinius - a legal trick devised by European bankers and merchants during the Middle Ages, designed to facilitate the borrowing of money at a fixed rate of interest (something that the Church fiercely opposed) through combining three different contractual agreements which in and of themselves were not prohibited by the Church.

One form of the argument against interest is that money is not a good and profit should be earned on goods and services only, not on control of money itself. Economists, however, believe that interest is a natural phenomenon, and one can indeed see from an economic perspective that Islamic banking is based on interest banking, in the sense of compensating investors for the time value of money .

While Islamic law prohibits the collection of interest, it does allow a seller to resell an item at a higher price than it was bought for, as long as there are clearly two transactions.

References

Categories: