Philosophy of Islamic Banking Finance Essay

A banking system that isA based onA the principles of Islamic law (also known Sharia) and guided by Islamic economics is known as Islamic banking. Two basic principles behind Islamic bankingA are the sharing of profit and loss and, significantly,A the prohibition of the collection and payment of interest. Economic justice requires a viable economic system supported by an efficient banking system. Interest based banking has proved to be inefficient as it fails to equitably distribute wealth which is necessary for the well-being of manking.On the other hand Islamic banking is efficent and ensures equitable distribution of wealth thus laying foundation for an inflation free economy and socially responsible banking.(The global finance crises,M.Kabir Hassan.)

Objections

Mr.Saqib Omer Saeed says

When people come across such Islamic banking products as Ijarah or lease, they wonder if it's the same that which a conventional bank offers. If we look closely Ijarah Muntahiya (Islamic Leasing Product) is very similar to the finance lease provided by a conventional financial institution, except the difference of the insurance cost (Takaful / Islamic Insurance) which has to be borne by theA lesseeA in the Islamic mode and it is built in the rentals. Another objection is the use of intrest rates as a benchmarking. Another objection against Islamic Banks is regarding their transactions with commercial banks including how some commercial banks have opened up Islamic banking branches. It makes one wonder whether the money being used in such transactions is free of interest or not?

Reservations

Some users of islamic financial services says that islamic banking is only a change name for conventional banking.Because they charge fee to the loan they give out which is equal to the interest that other commercial bank charge.That is why islamic banking appears to operate and give the similar type of return that conventional bank does to the people.

Evaluation of objections and reservations

Banking is such a sector which not only rules the economy of a community but a country well. The comparison to this effect makes the researcher more clear and Islamic scholars more informed about interest and its applications in the formal banking sector. The formal banking practices and the interest prohibitions if put in comparison can guide the bankers to develop a system to some extent free from interest. Interest has been very extensively applicable in the society it's a new term regarding financing by lending. Financing by lending takes two shapes i) loans with service charges and ii) Qarz-e-Hasana. The names are popular in Islamic society but the conventions in banking takes the shapes which are not normally acceptable to the Islamic society.(Interest free economy model,M.Arif.March,2012).

Philosophy of Islamic banking.

A The philosophy of Islamic banking is derived from Islamic Shariah.According to Islamic Shariah, Islamic banking cannot deal in transactions involvingA interest/riba (an increase created or sought over the principal of a loan or debt). A Further, they cannot deal in the transactions having the element of risky sale. Moreover, they cannot deal in any transaction, the subject matter of which isA invalid (haram in the eyes of Islam). Islamic banks focus on generating returnsA through investment tools which are Shariah compliant as well. Islamic Shariah linksA the gain on capital with its performance. Operating within the principles of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of finance.(Burj Bank limited ,july 27 ,2011).

Development

The Islamic banking system is currently spreading fast through many Arab andMuslim countries. The success of this new system is indicated by the rapid growth innumber of banks, branches, accounts, and sums of money it handles. This enormoussuccess has caused some Western style commercial banks, in Sudan for example, toconsider changing to the Islamic banking system. It is also drawing the attention of thegovernments of some Muslim countries to seriously supporting the system. (B.A Bashir, Successful development of Islamic bank).

Areas of operations

The areas of operatons of Islamic banks are as follows

Non fund based transactions

Non fund based transaction are those in which there is no outlay of funds or the transaction of funds is not involve.For all practicle purposes Islamic bank transact non fund based business and provide all of its services against approprate fee and charges.Here the assurance is given by the bank if the principle party defaults the bank is liable to pay to beneficiary.

Investment activities

The Islamic bank prepare savings, investment and other financial resources and also participate in providing equity and funds to entities like joint stock companies working under the Islamic banks. Some most commonly used modes of financing are Murahaba; In a murabaha transaction, the bank finances the purchase of a good or asset by buying it on behalf of its client and adding a mark-up before re-selling it to the client on a 'cost-plus' basis. Musharakah; It means a joint enterprise in which all the partners share the profit and loss of the joint venture. Bai'muajjal; Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis, which is termed bai' muajjal. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. Leasing or ijara; is also frequently practised by Islamic banks. Under this mode, the banks would buy the equipment or machinery and lease it out to their clients who may buy the items eventually, in which case the monthly payments will consist of two components, i.e., rental for the use of the equipment and instalment towards the purchase price.(M.Arif, University of Malaya, sep 1988).

3) Social activities

The Holay Quran says "If you loan to Allah a beautiful loan, He will double it to your credit (64:17) The Qur'an calls on all its followers to care for and support the poor and needy peoples. Islamic financial institutions are expected to provide special services to those in need. This is not confined to mere charitable donations but has also been institutionalised in the industry in the form of profit-free loans or Al Quard Al Hasan. An Islamic bank's business includes certain social projects, as well as charitable donations. Islamic banks provide profit-free loans. For example, if an individual needs to go to hospital or wants to go to university, we give what is called Quard Al Hasan. This Quard Hasan is normally given for a short period of one year and the Islamic bank does not charge anything for that. (AL Burka bank).

Financing under profit and loss sharing system

The profit-and-loss sharing system has its roots in the ancient form of financing practiced by Arabs since long before the advent of Islam. After the introduction of Islam, this system was permitted to continue and was consider right as a finance instrument. For this historical reason, scholars consider profit-and-loss sharing financial instruments to be the most real and most promising form of Islamic contracts (Ariff, 1982). Mudaraba (finance trusteeship) and Musharaka (equity partnership)are two such financial instruments based on the profit-and-loss sharing system, where instead of lending money to an entrepreneur at a fixed rate of return, the financier shares in the venture's profits and losses.In this mode of financing the risks and losses are shared by the financer along with the enterpreneur in the ratio of their respective capitals while the profits are shared in an agreed ratio.(The Economist 2001).

Potential of Islamic banking

Islamic world has a tremendous potentials.It has about 20% of the world population and as much of its land mass.It produces half of the world's oil and accounts for 40% of world export of raw material.The establishment of islamic banks is a recent phenomena and in short period of time ,over 100 islamic banks and financial instutions have been established in throughout the world.

Recommendations

To deliver top quality service to ensure that service standard of Islamic banking institutions isat par with conventional banking institutions. Aggressive marketing must be made in order to ensure that Islamic banking reaches the highest point in quickest possible time. The conflicting confusion and doubts must be removed from the mind of a general customer. Islamic banking rules should be uniform worldwide.

Conclusion

Don't find Islam in Islamic Banking. Implement Islam on youself then your economy to banking shall automatically be Islamic. The more we emphasize on the Islamization of Islamic banking, the more we will need to have an Islamic economy and the more we would want an Islamic economy, the more we will have to be good Muslims in all aspects of our society.

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