What is Islamic Banking?
Islamic banking is defined as banking system which is in consonance with
the spirit, ethos and value system 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 is Meant By Riba?
The word "Riba" means excess, increase or addition, which correctly
interpreted according to Shariah terminology, implies any excess compensation
without due consideration (consideration does not include time value of money). This
definition of Riba is derived from the Quran and is unanimously accepted by all
Islamic scholars.
The meaning of Riba has been clarified in the following verses of Quran (Surah Al
Baqarah 2:278-9)
"O those who believe; fear Allah and give up what still remains of the Riba if you are
believers. But if you do not do so, then be warned of war from Allah and His
Messenger. If you repent even now, you have the right of the return of your
principal; neither will you do wrong nor will you be wronged."
What is interest? Is there any difference between interest and
Riba?
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”
What is the difference between conventional banking and
Islamic banking?
The following are the main differential points between conventional
banking and Islamic banking.
What is meant by Shariah/Islamic Law?
Shariah lexically means a way or path. In Islam Shariah refers to the divine
guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet
Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations
by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs
and practices. Islamic Shariah or the divine law of Islam is derived from the following
four sources:
1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)
The end result of Islamic Banking and Conventional Banking
is the same. Why do they appear similar?
The validity of a transaction does not depend on the end result but rather the
process and activities executed and the sequence thereof in reaching the end. If a
transaction is done according to the rules of Islamic Shariah it is halal even if the end
result of the product may look similar to conventional banking product.
For example a normal McDonalds burger in USA and Pakistan may look similar, smell
similar and taste similar but the former is haram and the later is halal due to its
compliance of Islamic guidelines of slaughtering animals.
Similarly, if a person is feeling hungry, he may steal a piece of bread and eat or
alternatively buy a piece of bread to eat. The apparent end result would be same but
one is permissible in Shariah and the other is not allowed.
The same is also true for Islamic and conventional banking. Therefore, it can be
concluded that it is the underlying transaction that makes something “Halal”
(allowed) or “Haram” (prohibited) and not the result itself. Apparently, Islamic banks
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may look similar to conventional banks, however the contracts and product structures
used by Islamic banks are quite different from that of the conventional bank. In the
verse 2:275 of the Holy Quran, Allah the Almighty has responded to the apparent
similarity between trade and interest by resolutely informing that he has permitted
trade and prohibited Riba (though they may look similar to someone).
What are the major modes of Islamic banking and finance?
The following are the modes of finance which are or three categories:
1) Participatory modes of Finance
a) Mudarabah
b) Musharakah
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2) Non Participatory modes of Finance
a) Murabaha
b) Musawamah
c) Salam
d) Istisna
e) Ijarah
f) Ijarah wa Iqtina (Ijarah Muntahiyyah Bittamleek)
3) Sub contracts
a) Wakalah
b) Kafalah
c) Rahn