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Friday, 10 August 2007

Islamic banking article by IBLS

The main principle of Islamic finance and banking is the sharing of profits and the prohibitions of all forms of interest. Islamic law specifically prohibits usury and the collection and payment of interest (called riba in Islamic discourse). Generally, Islamic law also prohibits trading in financial risk, which is seen as a form of gambling. Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). This article provides valuable information on the Islamic rules for financial transactions and how the Islamic culture conducts their banking dealings. The contribution of the Muslim world to a new international economic order is based upon a renewed application of Islamic law (the Shariah) in modern economic and financial transactions. The Islamic financial model works on the basis of risk sharing. The customer and the bank share the risk of any investment on agreed terms and divide any profits or losses between them. Additionally, investments should only support practices that are not forbidden trades or are considered unlawful (haraam). An Islamic bank is not permitted to lend to other banks at interest. Islamic banking refers to a system of banking or banking activity that is consistent with principles of Shariah and guided by Islamic economics. Since this system of banking is grounded in Islamic principles, all the undertakings of the banks follow Islamic morals. Therefore, it could be said that financial transactions within Islamic banking are a culturally distinct form of ethical investing. For example, investments involving alcohol, gambling, pork, etc. are prohibited. Islam not only prohibits dealing in interest but also in liquor, pork, gambling, pornography and anything else that the Shariah deems unlawful. Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as follows: 1. While permitting the individual the right to seek his economic well-being, Islam makes a clear distinction between what is halal (lawful) and what is haraam (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity that are morally or socially injurious. 2. While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle, or to squander it. 3. While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat, an Islamic tax that obliges all Muslims to set 2.5% of their earnings aside for charitable purposes. 4. While making allowance for human failings, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole through its laws of inheritance. 5. Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive. The Dubai Islamic Bank has the distinction of being the world's first full-fledged Islamic bank, formed in 1975. Islamic financial products are available in the UK from a number of banks which offer current accounts and mortgages tailored for Muslims. The UK is home to the first wholly Shariah-compliant retail bank in the West, the Islamic Bank of Britain, which was authorized by the regulators in 2004. The FSA has also authorized the European Islamic Investment Bank, which is the first such investment bank. What is the difference between Islamic banking and conventional banking? The main difference between Islamic and conventional banking is that Islamic teaching says that money itself has no intrinsic value and forbids people from profiting by lending it, without accepting a level of risk, i.e., interest (known as riba) cannot be charged. To make money from money is prohibited; wealth can only be generated through legitimate trade and investment. Any gains relating to this trade are shared between the person providing the capital and the person providing the expertise. What is riba and why is it prohibited? In Arabic, riba literally means “excess”. Simply stated, riba is interest. Any amount, big or small, over the principal in a contract of loan or debt is riba, prohibited by the Quran, regardless of whether the loan is taken for the purpose of consumption or for some production activity. Prohibition of interest is ordained in Islam in all forms and intent. This prohibition is strict, absolute, and unambiguous. It therefore means that interest is prohibited as it leads to injustices (zulm), and Islam is against all forms of injustice and exploitation and seeks an economic system that aims at securing extensive socio-economic justice. The Islamic law of prohibition of riba was originally not based on economic theory, but on divine authority, which considers the charging of interest as an act of injustice. What does Hibah (“gift”) mean in Islamic banking? Hibah or “gift” in Islamic banking 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 profit on savings account balances. What does the term Mudarabah (profit/loss sharing) mean in Islamic banking? Mudarabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilize funds for his business activity. The entrepreneur provides expertise and management and is referred to as the Mudarib. 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 the capital provider bears all the losses if incurred. The profit-sharing continues until the loan is repaid. Islamic law does not require that the seller of a product be Muslim, or that its other services also be Islamic. This is the considered opinion of the Shariah Supervisory Committee. For example, all conventional banks charge and pay interest. The HSBC in the UK is an example of a conventional bank, but the HSBC is also a customer-driven institution, and the reason it provides Islamic products is to serve a genuine financial need among Muslims. However, their Islamic products are available for Muslims and non-Muslims alike in the UK. The funds obtained from HSBC Islamic finance clients are maintained separately from conventional funds, so that interest from the conventional activities does not enter their returns. Most importantly, all HSBC products and services are developed in consultation with and approved by Islamic scholars on the HSBC's Shariah Supervisory Committee. This process of product development, fund segregation, and Shariah review ensures that HSBC's Islamic products are free of interest and within the guidelines for commerce, finance and investment that are prescribed by Islamic law. - (IBLS)

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