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Learn More About: Islamic Banking
The world is an ocean of humanity with over 7.3 billion people sharing its resources. Our world is segmented based on multiple factors, with religion being an important identifier. There are hundreds of religions practiced today, with Islam being the second most practiced religion. There are over 2.1 billion followers of Islam globally and Islamic Banking has been designed to cater to their financial needs. Asia has the second largest percentage of Muslims after Africa, with the Middle East having a vast majority of them. UAE has a population of close to 10 million, with Muslims accounting for almost 75% of it.
What is Islamic Banking?
Islamic Banking refers to banking related activities which are in line with the basic principles of Islamic Sharia. Sharia refers to the rules and values which have been set forth in Islam and which are to be adhered to by the followers of Islam. It is a system which allows for the practical application of Sharia while simultaneously aiming to develop and improve Islamic economics. Islamic Banking believes in practicing strict moral and ethical values, at the same time providing all features that a conventional bank would offer. It is against acceptance or payment of any kind of interest or ‘Riba’, which sets it apart from conventional banks.
History and Origin of Islamic Banking
Islamic Banking might not be a very popular concept today but it has been around in various forms since the birth of Islam. Its origin can be traced back to the times of Prophet Mohammed, who practiced Sharia principles during trade. Middle Eastern traders continued this tradition when they traded with others as early as the 9th century. There were no formal institutions for such practices and they were limited to individual requirements. A more formal approach was adopted during the middle-ages though these too lacked definite structure. Islamic partnerships called “Mudarbah” have been in force for centuries, offering a glimpse into the Islamic banking system.
The current model of Islamic Banking has been around for about 5 decades, with the pioneers coming into the picture in the 1960’s. It took about a decade for this idea to gain prominence and by the 1970’s there were a few banks offering services based on Islamic principles of Sharia. The Islamic Development Bank established in 1974 was one of the first development banks to offer multiple services based on Sharia. Soon other exclusive Islamic Banks started to cater to the needs of clients and what started as small organizations in the Middle East started expanding their base. There were close to 150 Islamic Banks by 1995 and by the early 2000’s Islamic Banking had a presence in major countries across the globe, striving to cater to a wider population.
Islamic Banking still caters to a very less percentage of bank users, with just around 2% of the population opting for them, but this is soon set to change as these banks are seeing an annual growth of 10-15% per year. Islamic finance is said to be the fastest growing banking segment and is slated to grow stronger every year. Islamic Banking assets stand close to 1.5 trillion dollars today, indicating the high trust and faith people put in them.
Principles of Islamic Banking
Islamic Banking is based on the principle of Sharia, which mentions what is permitted and what is not allowed in this form of banking. Some of the basic principles are mentioned below.
- Should work within the framework of religion – Islamic Banking should follow the tenets of Islam and should not go against it. They should operate within suitable boundaries set forth in the Quran and according to Sunnah. Sunnah refers to the ways of life and teachings of Prophet Mohammed.
- Allow only ‘Halal’ activities – Halal refers to permissible activities which are allowed under the Sharia. Any actions which go against ‘halal’ principles are not allowed in Islamic Banking. This means they do not support activities which indulge in gambling, hoarding and having any connection to liquor or alcohol. Lending money for such purposes is not allowed. Usury based lending is also prohibited under Islamic Banking.
- No interest – Islamic Banks work on the principle of prohibition of interest. These banks do not charge or receive any interest or ‘Riba’ on the money lent or deposits made. It is believed that ‘Riba’ harms the well-being of everyone concerned when it enters the society and this is the reason why it is not permitted in Islamic banking.
- High Ethics – Islamic Banks strive to maintain high ethical standards. It is important to keep in mind the impact an investment can have on society and the environment before making it. The policies, products and services an investment can provide to the world should always be a factor while investing.
- Morality and Social Values – Islam is a religion which asks its followers to support and care for the poor and destitute. Islamic banks are also expected to offer special services and support to those who truly need them, thus ensuring they practice charity in all forms.
- Liability and Business Risk – Islamic Banking believes in fair principles, wherein all parties concerned are expected to have equal participation in both risk and profit. This principle stems from the saying “Profit comes with liability”, which essentially means that one is entitled to profit only when they are ready to bear the risks involved.
Commonly used terms in Islamic Banking
Islamic Banking often uses terms which might be new to the uninitiated. Here is a list of some of the popular terms and what they mean.
- Sharia – This refers to the laws of Allah, which all believers of Islam are expected to adhere to.
- Al Ajr – This refers to any fees, commission or wages that are charged for the services provided.
- Hibah – This essentially means a gift, a token voluntarily given by a debtor in return for a loan or service.
- Ijarah – This refers to a legal contract or right provided against a specified return, essentially to compensate for the work done. In simple words it means the task of leasing something.
- Murabaha – This refers to any sale on profit which has been mutually agreed upon by all parties involved.
- Mudharabah – This is the profit or loss sharing agreement between an individual and the bank. It is an investment partnership between the parties involved.
- Riba – This refers to interest. It literally means an increase and denotes any advantage obtained by a lender by lending out money.
- Takaful – This refers to the concept of Islamic insurance. Members collectively pool in their funds which are used to mutually assist each other.
- Wadiah – This means safekeeping. An Islamic bank is seen as a keeper and trustee of funds.
Islamic Banking Vs Conventional Banking
Conventional banking and Islamic banking are very different from each other. Right from the principle involved to profit sharing, they each follow different paths. The table below highlight some of the major differences between the two.
These follow the principles mentioned in the Sharia and cannot be changed or modified.
These follow manmade principles which are adjusted to suit specific needs and demands.
There is no concept of interest.
Interest forms an integral part of it.
Profit and Loss Sharing
Profit and loss sharing is promoted.
There is no concept of loss sharing.
Islamic banks are supposed to be zakat collection centres and pay zakat on their earnings.
There is no concept of zakat or charity.
Social welfare and impact of a project is kept in mind before sanctioning money for it.
The main concern is profitability and social welfare might be an afterthought.
Emphasis is on viability of projects.
Emphasis is on credit-worthiness of individual.
They do not charge any extra money as penalty.
Charge extra money as penalty in case of defaults on payment.
Islamic Banking Today
The scope for Islamic Banking has grown steadily since its inception. More people are now aware of this banking option and educating the population about the benefits associated with Islamic banking is bound to see more people choosing it. Almost all major banks offer Islamic banking options to clients, catering to diverse needs. Islamic banking has registered double digit growth in recent years, indicating a bright future for these banks. There is a huge untapped market for Islamic banking and this market is set to see new players offer Islamic banking solution to meet the demands of millions.