CONCEPT OF ISLAMIC BANKING AND FINANCE SYSTEM

Introduction 1.
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Bismillahir Rahmanir Rahim.

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Today, a fixed deposit in a

bank is considered an investment because it earns a return, and a loan is considered an asset by the bank for the same reason. But they are both interest-earning loans. Whatever the purpose, money is available only as a loan at interest. The banks and the depositors, being the lenders are not really concerned about whether the money was invested in a productive activity or consumed; neither is their return related to the result of any productive activity in which their capital was used. Even when the loan was intended for consumption, or the investment resulted in loss, the pre-determined interest must be paid. In contrast to this, in the Islamic tradition, the distinction between investment and lending had been clearly recognised and provided for, but unfortunately, its importance does not seem to have been fully appreciated even by the Muslims and acted upon. Therefore comes the requirement of understanding the Concept of Islamic Banking and Finance System which, Ladies and gentlemen, is the topic of my presentation. Aim and Sequence 2.
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The aim of my presentation is to highlight the Islamic stance

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regarding interest and enumerate the banking and finance system guided by Islamic Shariah. I will cover my presentation in the sequence shown in the slide. Definition 3. a. Bank. The word Bank is derived from Italian word
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BANQUE or German word BANC.

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Bank is a business that

receives, collects, transfers, safeguards money of the depositor,

exchanges currencies, and offers other financial services. (Like lending, investing to individuals, business or government). b. Islamic banking.
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General

Secretariat

of

the

Organization of Islamic Conference (OIC) states: An Islamic bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations Origin and History of Islamic Banking 4.
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The first modern experiment with Islamic banking was

undertaken in Egypt under cover, without projecting an Islamic image, for fear of being seen as a manifestation of Islamic fundamentalism
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which was anathema to the political regime.

The pioneering effort, led

by Ahmad El Najjar, took the form of a savings bank based on profitsharing in the Egyptian town of Mit Ghamr in l963. This experiment lasted until l967, by which time there were nine such banks in the country.
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These banks neither charged nor paid interest. They invested mostly by engaging in trade and industry, directly or in partnership with others, and shared the profits with their depositors.
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Thus, they functioned

essentially as saving- investment institutions rather than as commercial banks. The Nasir Social Bank, established in Egypt in l97l, was declared an interest-free commercial bank. 7.
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The Islamic Development Bank (IDB) was established in l974 by

the Organization of Islamic Countries (OIC), but it was primarily an intergovernmental bank aimed at providing funds for development projects in member countries. The IDB provides fee-based financial services and profit-sharing financial assistance to member countries. The IDB
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operations are free of interest and are explicitly based on Shariah principles. Islamic Prohibition on Interest 8.
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The Arabic word Ribah means interest or usury. Two different

meanings were used in against of Ribah in Quran. In the 1st one Ribah means interest and in the 2nd one Ribah means Usury. Let us look at both of the meanings. (a)
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The Quran speaks about Ribah in six different

places and forbids human being taking it. The prohibition of interest took place gradually as it happened in case of some other rulings too like prohibition on intoxication, implementation of Hizab etc. The first time The Quran speaks about interest is in Verse 39 of Surah 30 (Rum)- Click That which ye lay out for increase through the property of (other) people, will have no increase with Allah: but that which ye lay out for charity, seeking the Countenance of Allah, (will increase): it is these who will get a recompense multiplied. (b) The 2nd time the Quran speaks about interest is in Verse 161

of Surah 4 (Nisa)- Click That they took usury, though they were forbidden; and that they devoured men's substance wrongfully; we have prepared for those among them who reject faith a grievous punishment. (c) Interest, be it a flat one or the one of cyclical; be it a simple

one or compound; be it in the micro credit economy or in macro is unlawful. The 3rd time the Quran speaks about interest is in Verse 130 of Surah 3 (Al Imran)- Click
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O ye who believe! Devour, not usury doubled and multiplied; but fear God; that ye may (really) prosper.

(d)

At the time of revelations of Quran, there were people, who,

seeing the profit from a trade, used to claim that interest and profit are the same. Ladies and Gentlemen, there are still such people who claim the same, but they dont consult the Quran, as the 4th time the Quran speaks about interest is in Verse 275 of Surah 2 (Baqara)Click

Those who devour usury will not stand except as stand one whom the Evil one by his touch hath driven to madness. That is because they say: "Trade is like usury," but God hath permitted trade and forbidden usury. (e) The 5th time the Quran speaks about interest is in Verse 276

of Surah 2 (Baqara)- Click God will deprive usury of all blessing, but will give increase for deeds of charity: For He loveth not creatures ungrateful and wicked. (f) The 6th time the Quran speaks about interest is in Verse 279Click

280 of Surah 2 (Baqara)-

O ye who believe! Fear God, and give up what remains of your demand for usury, if ye are indeed believers. If ye do it not, take notice of war from God and His Apostle. But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly. 9. Ladies and gentlemen, I wonder, which Muslim today on earth can

challenge Allah and his Rasul (SM) to wage a war against him? Now question might arise, who all are the people deserving such war from Allah and his Rasul (sm). Hadith says about it- Click
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Allah curses those people who give interest, who take interest, who accounts the interest and those who be witness of interest 10. There are several verses of Hadith which condemns interest .One

of those Hadiths which puts strong reservation on the dealings of interestClick

Interest will earn seventy sins, the least those equals to

violating one's own mother.

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Objectives of Islamic Banking

11. The primary objective of establishing Islamic banks all over the world is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the objectives of Islamic banking when viewed in the context of its role in the economy are: click (a) Interest-based banking is unanimously identified as antiIslamic. That means all transactions made under conventional banking are unlawful according to Islamic Shariah. Thus, the emergence of Islamic banking is clearly intended to provide for Shariah approved financial transactions. (b)
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Islamic banking is more development- oriented than its

conventional counterpart. The concept of profit sharing is a built-in development promoter since it establishes a direct relationship between the banks return on investment and the successful operation of the business by the entrepreneurs. click (c) The foundation of the Islamic banking system is that it investment of financial resources into those promotes the to the economy.
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projects that are considered to be the most profitable and beneficial

(d)

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The most important objective of Islamic banking is to parties: the bank, the depositors and the

ensure equitable distribution of income and resources among the participating entrepreneurs. Concepts of Transactions in Islamic Banking and Finance 12. Ladies and gentlemen, keeping in mind the short time frame, Ill

discuss most commonly adopted transactions in Islamic Banking and Finance system. They are: Al Wadiah, Mudarabah, Musharakah, Ijarah, Qard al Hasana.
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The first two are banking and last three are islamic

finance transactions. 13.

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Wadiah (Safekeeping).

In Wadiah, a bank works as a safe

keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, when the depositor demands it. The depositor, is neither interested in the profit nor the loss of the bank. The bank at its own discretion may reward a 'hibah' (gift) as a form of appreciation for the use of funds. 14.
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Mudarabah (Profit Loss Sharing).

Mudarabah

is

an

arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilize funds for its business activity.
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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. It is a form of partnership where one party provides the funds while the other provides expertise and management.
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15.

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Musharakah (Joint Venture).

This

concept

is

normally

applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio, while loss is borne by each partner strictly in proportion to respective capital contributions. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. 16.
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Ijarah (Hire Purchase).These are variations on a theme of

purchase and lease back transactions. 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. 17.
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Qardul Hassan (Beautiful Loan).

Qard

means

loan,

Hasan means beautiful. This is a loan extended on a goodwill basis mostly to the poor people. There is no equivalent of Qard e Hasana in any system of modern banking/ finance syatem. The debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay a token of appreciation to the creditor. This kind of loan is given for a shorter duration. reference is given in Quran, Verse 245 of Surah 2 (Baqara) Who will loan to Allah, a beautiful loan, which Allah will double and multiply in to his account
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The

The Quran also says in Verse 261 of Surah 2 (Baqara):

The parable of those who spend their substance in the way of God is that of a grain of corn: it groweth seven years, and each year hath a hundred grains. God giveth manifold increase to whom He pleaseth: And
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God careth for all and He knoweth all things.

It says that one corn will result 700 corns if it is spent in the way of

Allah. In short 700 times, or in business terminology minimum 70000% profit is promised. Distinguishing features of Islamic Banking 18. An Islamic bank has several distinctive features as compared to its conventional counterpart. They are click Conventional Banks Islamic Banks 1. The functions and operating 1. The functions and operating modes modes of conventional banks of Islamic banks are based on the are based on manmade principles of Islamic Shariah. principles. 2. The investor is assured of a 2. In contrast, it promotes risk sharing predetermined rate of interest. between provider of capital (investor) and the user of funds (entrepreneur). 3. It aims at maximizing profit 3. It also aims at maximizing profit but without any restriction. 4. It does not deal with Zakat. subject to Shariah restrictions. 4. In the modern Islamic banking system, it has become one of the service-oriented Zakat. 5. Lending money and getting it 5. Participation in partnership business back
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functions

of

the

Islamic banks to collect and distribute

with

interest function

is of

the is the fundamental function of the the Islamic banks.

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fundamental

conventional banks.

6. Its scope of activities is 6. Its scope of activities is wider when narrower in comparison with compared with a conventional bank. It Islamic bank. interest Makes 8. becomes no effort income to is, in effect, a multi-purpose institution. prominent. interest. Its ultimate aim is to ensure to ensure growth with equity. the 8. Since it shares profit and loss, the project appraisal and 7. In it very often, banks own 7. It gives due importance to the public

growth with equity. Since from advances is fixed, it gives little Islamic banks pay greater attention to importance developing developing expertise in project appraisal evaluations. and evaluations. 9. The conventional banks give 9. The Islamic banks, on the other greater emphasis on credit- hand, give greater emphasis on the viability of the projects. worthiness of the clients.

10. The status of a conventional 10. The status of Islamic bank in bank, in relation to its clients, is relation to its clients is that of partners, that of creditor and debtors. investors and trader.

Hurdles to Islamic Banking & Finance 19. (a)

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To Implement Islamic Shariah into the practical scenario, a

group of honest, God conscious, sincere manpower is essential who should be trained in both banking and the sharah. (b)
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The growing interest towards Islamic banking & finance

has caused many fake, fraud and shrewd people and agencies to open banking, cooperation and micro-credit organizations, which just uses the name of Islamic Shariah but never accepts and deals accordingly.
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(c)

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Muslim population not only tremendously lacks practicing

on Islam but also lacks knowledge on Quranic and Shariah rulings regarding Islamic banking & finance. (d)
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Absence of policy regarding functions and operations of

Islamic banks; especially about the resultant interest from the liquidity deposition into the central bank. A bank can not be an entire Islamic bank till the central bank does not promulgate a separate Islamic banking policy. (e)
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Improper/ non adherence of Shariah in order to cut short

procedures and please clients. Achievements of Islamic Financial System 20. Ladies and gentlemen, though Islamic banking and finance is a

newer concept in economy and fewer in numbers all over the world, it achieved inspiring progress in last three decades allover the world. It achieved click (a) (b)
(c)

Substantial progress in terms of the economic development.

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Generating awareness of the subject. Accelerated rise in the number of banks, their branches, Diversified modes of financing: there is hardly any financial

volume of deposits and assets.

(d)
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need that cannot be financed with the help of these modes

(e) (f)
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Infrastructure institutions. Increased domestic and international acceptance of the Phenomenal increase in the volume of literature on the

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system skepticism has declined.

(g)
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subject by both Muslims and non-muslins.

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Conclusion

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Islam is not merely a religion; it is a set of code of conduct which The elimination of interest from the

encompasses every spheres of human life and guides towards the earthily and heavenly salvation. economic system is suggested by Islam, intended to promote economically just, socially fair and ethically correct dealings according to Islamic principles. Profit from trade, reduces the cost of product, increases the demand, and thereby increases the supply and the production in general. The increased production necessarily increases the job opportunity or labor thus harmonious trade creates powerful economic incentives, and brings about co-operation and co-participation in all walks of life. Moreover, prohibition of the practice of hoarding in the Quran applies to money also. Islam wants to make it sure that ones money is used productively for oneself and the community.

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