FINANCE

Islamic Banking

Islamic Banking

Introduction

System of banking or banking activities that is in compliance with the basic Islamic Shariah principles is referred as “Islamic Banking”. The Shariah prohibits “Riba” i.e. accepting and borrowing interest rates, therefore, Islamic banking is also known as interest free banking system. The businesses that offer good interest rates or services are strictly prohibited in Islamic banking system and in fact they are considered Haraam (forbidden). Islamic banking provides same facilities as conventional banking system but it follows Shariah rule or Fiqh al-Muamlat (www.theislamicbanker.com). Islamic finance and its services are especially designed to adhere to Sharia principles (Islamic Law). Though it is exclusively designed for Muslims, however, non Muslims can also buy these services (www.theislamicbanker.com).

Discussion

Shariah, Key Principles of Islamic Finance and Its Sources

Islam is belief system that not only incorporates the relationship of God with his man, but also offers the codes that regulate the entire way of life of Muslims. The Quran sets out the entire Islamic system by providing it in notions of fairness, equity, morality, justice, and many other values. Quran is the basis for Shariah, which provides us with the Islamic laws and regulations (Lovells, 2004, p.2).

The Shariah provides ruling (basis) for all the aspects of life from matters of state, whether it is about supremacy and political relations, or daily live and financial transaction issues. Muslims believe that the manner of living a life is expressed by God's guidance in the form of these set rules and principles. These Shariah principles are derived from two major resources: the Quran and the Sunnah. According to Muslim's belive the Quran is revealed to the Prophet Muhammad (P.B.U.H) by the Almighty God. Where, the practices and sayings of Prophet Muhammad (P.B.U.H) are traced as the Sunnah (Gait & Worthington, 2007, p.4). Fiqh is the Islamic body of law which provides specific ruling derived from these sources (www.simmons-simmons.com).

Financial transactions are among the most important aspects that are controlled by Sharia, which ensures more equitable distribution of wealth and income among Muslims in Islamic economies (Gait & Worthington, 2007, p.7). There are five general principles of Islamic finance, which are stated below:

Riba (usury or interest) Prohibition

One of the major principles of Islamic finance is the prohibition of Riba in transactions. Linguistically, meaning of Riba is increase. The Shariah concept of Riba, in a commercial context, is same as the interest payment in commercial banking. When cash is lend or return back with interest charges, the Riba arises, whether the interest is floating or fixed. Riba can also occur when currency or money is exchanged in an uneven quantity (Riba al-fadl) or in even quantity with both payments or one payment deferred (Riba al-nasia). Shariah principles allow return on funds only when the success occurs in business venture, but not on the basis of mere act of lending money (Gait & Worthington, 2007, p.7-9).

Gharar (risk & Uncertainty) Prohibition

Under the Sharia ruling, agreements which involve a subsequent extent of doubt are not accepted as ...