Published On:20 June 2011
Posted by Indian Muslim Observer

Understanding Islamic Banking system

By Disu Kamor

In Judaism, Christianity and Islam renting the use of money is prohibited. Riba (in Qur’an) or ribbit (in the Old Testament) is the act of renting the use of money at a price called interest rate. This concept of renting the ‘use of money’ is the origin of the word ‘usury’, in contrast to today’s definition of ‘usury’ as excessive rate. Usury, lending of money on interest, regardless of the rate of interest is prohibited in the Quran when Almighty Allah says: ‘…Truly, those who believe, and do deeds of righteousness, and perform prayers, and give voluntary charity, they will have their reward with their Lord. On them shall be no fear nor shall they grieve. O you who believe! Fear Allah and give up what remains (due to you) from usury (from now onward).” (2:277-278). In addition, specific words of the prophet Muhammad (SAW), which is an instructional source in Islam, prohibit it.

Islamic banking refers to a system of banking or banking activity that is consistent with Islamic law (Sharia’h) principles, called fiqh muamalat (Islamic rules on transactions), and guided by Islamic economics. Islamic banking is often thought to be financing the needs of the Muslim community alone but this notion, as it will be seen, is wrong. With the rapid growth of the worldwide economy along with the expanding economy in the Islamic countries, Islamic banking is evolving to play a vital role in today’s global village.

Besides prohibiting the payment and/or collection of interests, regardless of the purpose for which loans are made and the rates at which interests are charged, Islamic law also prohibits activities dealing with alcohol, pork, gambling, pornography and anything which Islamic law deems unlawful. The Islamic banking system is therefore a comprehensive system that goes beyond an agreement to share profits and loss in commercial dealings. It is the development of an Islamic economic order which ensures social justice, such as forbidding all forms of economic activities which are morally or socially injurious, ensuring ownership of wealth legitimately acquired, allowing an individual to retain any surplus wealth and seeking to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, is enabled.

Due to the rules of the Islamic banking, Islamic finance products are often based on the principles of risk sharing and profit sharing. Such sharing principles can provide acceptable financial returns to investors by providing potential profit in proportion to the risk assumed. This type of structured products can satisfy the demands of investors in the contemporary environment within the guidelines of the Islamic law. The most active financing provided are in the areas of trade commodity finance, property and leasing (common concepts used are listed at the end of this article). It can therefore be seen that the commercial purpose of Islamic banking is the same as conventional banking but it needs to operate within the principles stated above.

Some of the features of Islamic investing have always held an appeal for non-Muslim investors and individuals. Because Islamic funds and investors screen out companies to exclude those that take part in activities that are considered unethical, according to the Islamic law, and because companies that are overleveraged or that rely too heavily on accounts receivable are screened out, many non-Muslim investors who are not only interested in the risk/reward relationship of their investment, but who are also concerned with issues of accountability and social responsibility have been attracted to play major roles in developing the industry. Steven Amos, the Islamic Bank of Britain’s head of marketing, recently told the London-based Times newspapers that his bank is prospering as High Street banks alienate existing customers. “Our core business will always be Muslims, but the numbers of non-Muslims are really picking up. We’ve had massive interest - and that’s down to a number of reasons, all of which have kept us insulated from the credit crunch.”

The advisory boards for the different modes of Islamic finance need to be of certain credentials. The reason for this is simple. The primary users of Islamic financial services assign great importance to Shari’ah compliance of the services they use because for them it is a matter of faith. It is understandable from the Qur’anic verse referenced above that Shari’ah non-compliance entails a serious personal consequences for Muslims and for the businesses offering the service, it represents an operational risk that can result in withdrawal of funds from and instability of an Islamic bank or fund, irrespective of its initial financial soundness. Ongoing compliance is hence a serious matter for any organisation selling Islamic services, in addition to its compliance with other regulatory requirements as spelt out in the BOFIA (Banks and Other Financial Institutions Act). Also, an appropriate legal, institutional and tax framework is a basic requirement for establishing sound financial institutions and markets. Islamic jurisprudence offers its own framework for the implementation of commercial and financial contracts and transactions and surely only Muslim experts in Islamic finance, economics and jurisprudence can provide such a specialist service.

The stubborn belief that the restriction of the membership of the Islamic banking advisory boards to Muslims of certain expertise will exclude non-Muslims from the system is therefore not tenable. The unsupported assertion has been hyped further by claims that the real ambition of the Central Bank governor is to ‘Islamise the banking sector’. While this assertion is understandably vexing to every objective and fair-minded person, there is no better answer to it than the words of the celebrated Central Bank governor himself. Tracing the history of the CBN policy, he said at the time he became governor, there was a circular ‘already out there collating inputs from the general public, and was finally put together by the director, financial policy and regulation, whose name is Christian Chukwu. So, if there is a grand process for Islamisation of the banking sector, then it started with Professor Charles Soludo, Reverend Tunde Lemo, and Mr Christian Chukwu.’ Hopefully, this categorical answer will put the issue at rest. The claim that introducing the Islamic banking system is a breach of the Nigerian secular constitution is akin to claiming that the establishment of religious schools and universities in Nigeria, with their faith-based management boards, a threat to democracy and secularism.

Islamic banking is growing and being introduced in Muslim and Western countries, and are driven first and foremost by a global trend amongst Muslims to become more observant of their faith. Today, Islamic banking is sought by Muslims and non-Muslims alike. US$822 billion have now been invested into Islamic assets worldwide, with the near future forecast running into US$4trillions. Nigerian businesses must gear up to take a slice of this cake. Perhaps, this explains why the Vatican put forward the idea that banks should look at the rules of Islamic finance to restore confidence among their clients at a time of global economic crisis. The Vatican’s official newspaper Observatore Romano stated during the last credit crunch that “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”

Islamic beliefs create two different opportunities for businesses everywhere- the opportunity presented by the well-off business people and individuals, and in Nigeria, the opportunity presented to the financial sector to become the African hub of Islamic banking on the continent. There is a real and substantial market need for sharia’h-compliant products in Nigeria and the newly approved guidelines will only allow conventional banks adapt to this need. Change may not always be easy but we must be fully prepared to rise to the challenge. In this regard, it is essential that financial organisations do not adopt the mindset that the relationship between them and the market is one of action and reaction only. Instead, we ought to think collectively through the issues and work together to address them successfully to harness the many great benefits the future of Islamic banking in Nigeria promises. Muslims are keen to ensure the safe and sound operations of the banking system and to achieve that objective over time progressive financial organisations must adapt to changing customer needs. Meeting the customer demand for Islamic banking services will require that the industry and the advisory boards have a particularly strong and sincere dialogue, and a faithful observance of the Islamic rules. The Islamic banking with its unique principles and unique benefits will only strengthen the Nigerian economy it will not weaken it. Also, as it is interest free, risk sharing and profit sharing mode is recognised by our law, the system will coexist with interest-based conventional financing.

Modes of Islamic Finance and Islamic Finance Terminologies

Murabaha: Literally it means a sale on mutually agreed profit. In Murabahah, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement.

Ijarah: Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended.

Ijarah-Wal-Iqtin: A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental, together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee.

Musharakah: Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business.

Musawamah: Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former.

Istisna’a: It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery.

Bai Muajjal: Literally it means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal. •Mudarabah: A form of partnership where one party provides the funds while the other provides expertise and management.

Bai Salam: Salam means a contract in which advance payment is made for goods to be delivered later on. Hibah (Gift): This refers to a payment made willingly in return for a benefit received.

Qard hassan/Qardul hassan (good loan/benevolent loan). This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor.

Sukuk (Islamic bonds): financial certificates that are the Islamic equivalent of bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam.

Wadiah (safekeeping): In Wadiah, a bank is deemed as a keeper and trustee of funds.

(Courtesy: Daily Independent)

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Posted by Indian Muslim Observer on June 20, 2011. Filed under , , , , . You can follow any responses to this entry through the RSS 2.0. Feel free to leave a response

By Indian Muslim Observer on June 20, 2011. Filed under , , , , . Follow any responses to the RSS 2.0. Leave a response

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