Islamic Banking Essay Example

These authors recognized the importance of commercial banks and the negative effects of interest, proposing a banking system centered around Mudarabha- profit and loss sharing. Over the next two decades, interest-free banking gained more attention due to political interest in Pakistan and the emergence of young Muslim economists.

During this period, multiple works were dedicated to the subject. Muhammad Uzair (1955) was responsible for one of the initial works. In the late sixties and early seventies, Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971), and Baqir al-Sadr (1961, 1974) contributed with a series of influential works.

During the early seventies, there was an increase in institutional involvement in Islamic finance. Various conferences and studies were conducted to practically apply theories, leading to the establishment of interest-free banks. Notable events during this time include the Conference of the Finance Ministers of the Islamic Countries in Karachi in 1970, the Egyptian study in 1972, the First International Conference on Islamic Economics in Mecca in 1976, and the International Economic Conference in London in 1977.

One significant outcome of this period was the creation of the Islamic Development Bank, which emerged as an inter-governmental bank in 1975. Additionally, Dubai Islamic Bank was founded by a group of Muslim businessmen from different countries, becoming the first private interest-free bank. Moreover, two more private banks called Faisal Islamic Bank were established respectively in Egypt and Sudan during 1977.

The Kuwaiti government established the Kuwait Finance House in the same year. Prior attempts to establish small-scale interest-free banks were made in Malaysia in the mid-1940s and Pakistan in the late-1950s, but unfortunately, both endeavors were unsuccessful.

The Malaysian government introduced the "Pilgrim's Management Fund" in

1962 to help potential pilgrims save and earn profits. In 1963, a savings bank was set up in Mit-Ghamr, Egypt. It initially had success but eventually closed for various reasons. However, this initiative led to the creation of the Nasser Social Bank in 1972. The Nasser Social Bank is still operational today but now focuses on social objectives instead of commercial ones. Over the past decade, more than 50 interest-free banks have emerged since the first private commercial bank was established in Dubai. These banks are mainly found in Muslim countries but can also be found in Western Europe, including Denmark, Luxembourg, Switzerland, and the UK. Many banks were established between 1983 and 1984.

In the subsequent years, there has been a significant decrease in numbers. While most countries saw interest-free banking being established through private initiatives and limited to one specific bank, Iran and Pakistan diverged from this trend. In these countries, the government took charge and implemented interest-free banking across all banks. In 1981, both governments initiated measures to introduce interest-free banking. In Pakistan, effective from January 1, 1981, all domestic commercial banks were allowed to accept deposits based on profit-and-loss sharing (PLS). Subsequently, on January 1, 1985, additional measures were introduced to formally transition the banking system, over the following six months, into an interest-free model.

From 1 July 1985, banks were prohibited from accepting interest bearing deposits and all existing deposits became subject to PLS rules. However, certain operations were still permitted under the previous system. In Iran, certain administrative measures were implemented in February 1981 to eliminate interest from banking operations. Interest on all assets was replaced by a maximum service charge

of 4 percent and a 'profit' rate of 4 to 8 percent, depending on the economic activity. Interest on deposits was also changed to a 'guaranteed minimum profit'.

Starting in August 1983, with the introduction of the Usury-free Banking Law, a fourteen-month transition period commenced in January 1984. By March 1985, the entire system had successfully converted to an interest-free model. During the 1980s, writings and conferences shifted focus from discussing concepts and possibilities of interest-free banking to evaluating their performance and impact on the global economy. Notably, events like the Conference on Islamic Banking: Its impact on world financial and commercial practices held in London in September 1984, the Workshop on Industrial Financing Activities of Islamic Banks held in Vienna in June 1986, the International Conference on Islamic Banking held in Tehran in June 1986, and finally, the International Conference on Islamic Banking and Finance: Current issues and future prospects held in Washington D.C., demonstrated worldwide interest.

Examples of events that fall into this category include the Islamic Banking Conference held in Geneva in October 1986, the Conference ‘Into the 1990’s with Islamic Banking’ held in London in 1988, and the Workshop on the Elimination of Riba from the Economy held in Islamabad in April 1992. Throughout this period, there have been numerous articles, books, and PhD theses dedicated to the subject of Islamic Banking. It is worth noting M. Akram Khan's work on annotated bibliographies of all published (and some unpublished) works on Islamic Economics (including Islamic Banking) from 1940 and earlier.

The text contains information about the usefulness of the mentioned works for students of Islamic Economics and Banking. It also highlights the inclusion of

works in English, Urdu, and Arabic, along with bibliographies by M. N. Siddiqi from 1980 and 1988. It mentions that Turkish literature can be found in Sabahuddin Zaim's work from 1980. Additionally, it states that interest-free banks generally agree on basic principles but differ in their application.

The differences in Islamic banks are caused by various factors, including country laws, bank objectives, individual circumstances and experiences, and the need to interact with other interest-based banks. In the following paragraphs, I will discuss the common features found in all banks.

Deposit Accounts: Islamic banks offer three types of deposit accounts - current, savings, and investment.

Current Accounts: These accounts are similar to those found in conventional banks, providing guaranteed deposits.

Savings Accounts: Islamic banks operate savings deposit accounts differently. Some banks allow depositors to use their money while guaranteeing the full amount will be returned by the bank.

Banks use various methods to encourage clients to deposit with them but do not promise any profits.

Some banks consider savings accounts to be similar to investment accounts, but with less strict rules regarding withdrawals and minimum balances. Although the capital is not guaranteed, these banks invest the funds from such accounts in relatively safe short-term projects. Therefore, lower profit rates are expected, and only on a portion of the average minimum balance, as a significant level of reserves must be maintained to meet withdrawal requests.
On the other hand, investment accounts accept deposits for a specific or unlimited period. Investors agree in advance to share the profit or loss in a predetermined ratio with the bank.

Capital is not assured. There are various techniques that banks employ to obtain assets or

fund projects, which can be classified into three categories: investment, trade, and lending.

Investment financing involves three main methods. The first is Musharaka, where a bank partners with another entity to create a joint venture, with both parties contributing different levels of involvement in the project. The sharing of profits and losses is determined by an agreed arrangement, similar to a joint venture concept.

The venture is a separate legal entity and the bank may gradually withdraw after an initial period. b) Mudarabha involves the bank providing finance while the client contributes expertise, management, and labor. Both partners share profits based on a predetermined proportion, but if there is a loss, the bank bears the total loss. c) Financing is based on an estimated rate of return. In this scheme, the bank estimates the expected rate of return for the project it is asked to finance and provides funding with the understanding that at least that rate will be repaid to the bank.

(Maybe we can talk about the rate.) If the project goes over the estimated rate, the client will get the extra profit. If the profit is lower than expected, a lower rate will be accepted by the bank. Moreover, if there's a loss, the bank will also share part of it. There are different ways to finance trades. The main method includes mark-up, where the bank buys an item for a client and later gets paid back both the price and an agreed-upon profit.

b) The bank provides the service of leasing, in which they purchase an item on behalf of a client and lease it to them for a specified period. The client becomes the

owner by paying the remaining balance at the end of the lease.

c) Another service offered by the bank is hire-purchase, where they buy an item for a client and rent it to them for an agreed rent and period. At the end of this rental period, the client automatically becomes the owner.

) Sell-and-buy-back is a transaction where a client sells their property to the bank at an agreed price and receives immediate payment. After a specified time, they can repurchase the property from the bank at an agreed price.

e) Letters of credit involve using funds from the bank to guarantee import of items for clients. The profit from selling these items or markup basis is shared between the bank and client.

Lending: There are two main forms of lending:

a) Loans with a service charge do not have interest but include a service charge assessed by banks to cover expenses. Authorities may set limits on this charge.

b) No-cost loans are specifically allocated by each bank for individuals in need, such as small farmers, entrepreneurs, producers, etc., without any associated costs.

Islamic banks provide a range of services to their customers, including interest-free loans for small and large businesses, as well as needy consumers. They also offer overdrafts up to a certain maximum without any charges. In addition, the banks provide other services like money transfers, bill collections, and foreign currency trade for a commission or charges. However, Islamic banks encounter challenges in financing specific areas under the PLS scheme such as participating in long-term low-yield projects, providing finance to small business owners, granting non-participating loans to running businesses, and financing government borrowing.

Long-term projects are problematic for 20 Islamic

Banks in 1988 as only less than 10 percent of their total assets are allocated towards medium- and long-term investment. Consequently, these banks are either unable or unwilling to participate in such projects, resulting in an unsatisfactory situation. The table, titled "Term Structure of Investment by 20 Islamic Banks, 1988," provides further details on the distribution of investments among different types, with short-term investments amounting to 4,909 and their percentage of the total unspecified.

8 68. 4 Social lending 64. 2 0. 9 Real-estate investment 1,498. 2 20. 9 Medium- and long-term investment 707.

7 9. 8 Source: Aggregate balance sheets prepared by the International Association of Islamic Banks, Bahrain, 1988. Quoted in: Ausaf Ahmed (1994). * Unit of currency not given.Government Borrowing: In all countries the Government is a significant contributor to the demand for credit, both for short-term and long-term purposes. These borrowings differ from business loans as they don't always serve investment purposes, and even when they do, they are usually long-term and have low yields.

The difficulties in estimating a rate of return on loans granted under the PLS scheme are multiplied by the fact that in Iran, financial transactions between elements of the public sector, including Bank Markazi and nationalized commercial banks, can occur at a fixed rate of return that is not considered interest. This allows the Government to borrow from the nationalized banks without violating the Law. However, this practice could lead to indexing bank charges to the fixed rate rather than the actual profits of borrowing entities. Additionally, existing banking laws in Iran do not allow banks to use depositors' funds for business enterprises.

However, the basic asset acquiring method of

Islamic banks requires new legislation and/or government authorization to establish them. For instance, in Iran, comprehensive legislation was passed to establish Islamic banks, while in Pakistan, the Central Bank was authorized to take necessary steps. In other countries, banks either found ways to utilize existing regulations or were granted special accommodation. In all cases, government intervention or active support was crucial for establishing Islamic banks operating under the PLS scheme. Despite this, additional auxiliary legislation is still needed to fully achieve the objectives of Islamic banking.

For instance, in Pakistan, the new law is implemented without making any essential modifications to the current regulations concerning contracts, mortgages, and pledges.

There have been no laws introduced to define modes of participatory financing, such as Musharakah19 and PTCs. It is assumed that if there is a conflict between the Islamic banking framework and the current law, the latter will take precedence. Ultimately, the relationship between the bank and the client, specifically that of creditor and debtor, remains unchanged as stated by the existing law.

The current banking law was created to primarily safeguard credit transactions. However, when applied to other forms of financing, it treats them as credit transactions as well. This has raised doubts among banks about the acceptability of certain contracts in court, despite being consistent with the principles of Islamic banking. Consequently, there are incentives for default and abuse. In Iran, while the law establishing interest-free banking is comprehensive, the absence of clear definitions of property rights may have limited bank lending.

There has yet to be a specific legislative and legal expression of what qualifies as "lawful and conditional" private property rights. This lack of

clarity may discourage investment lending in agricultural and industrial sectors, leading to a concentration of assets in short-term trade financing instruments. Iran and Pakistan are committed to eliminating riba from their economies and have made significant progress towards this goal. However, there are still many legal challenges to be addressed. In other Muslim countries, the government actively or passively supports the establishment of Islamic banks due to religious beliefs. This is not the case in non-Muslim countries, where establishing Islamic banks requires compliance with existing laws that are generally not favorable for profit and loss sharing (PLS) financing in the banking sector.

In section 4, we will explore some of the problems related to the involvement of banks in specialized non-bank activities. Dr Hasanuz-Zaman discusses the traditional tasks of banks and questions their ability to take on additional functions under the PLS scheme. The evolution of banks as purely financial institutions is due to historical reasons. They excel in attracting and safeguarding money, providing safe lending and profitable investment opportunities, and possessing the ability to create means of payment. Banks must maintain a balance between income, liquidity, and flexibility when allocating funds. Factors such as capital position, loan profitability, deposit stability, economic conditions, monetary and fiscal policies, personnel experience, and credit needs must all be carefully considered. Currently, these banks operate under a fixed rate of return that is partially shared with depositors.

The entire focus of a bank is money management and it does not function as an entrepreneur, trader, industrialist, contractor, or caterer. This raises the question: can a bank, with all these limitations, claim expertise in trading or entrepreneurship that is necessary for

musharakah or mudarba contracts? Can it also act as the owner of heavy machinery, transport vehicles, or real estate to become a lessor? Additionally, can it act as a stockist to purchase and resell imports and exports needed by legitimate traders? Furthermore, if the bank is not historically or practically competent for these roles, its claim to share profits as a working partner, trader, or lessor becomes questionable. Traditional banks conduct some project evaluation when providing large medium- and long-term loans. However, they are unable to carry out the detailed evaluation required for a PLS scheme, including determining rates of return and their timeline. Detailed accounting and monitoring necessary to assess actual performance are also beyond the capabilities of conventional banks. Islamic banking requires these evaluations for almost all advancements made by the bank, but standardized and reliable techniques have yet to be developed.

This is complicated by the fact that no agreement has been reached on the principles. The task is unprecedented and requires a significant amount of work and skilled personnel, making it a daunting prospect. In summary, according to Dr. Hasanuz Zaman, the techniques used by interest-free banks do not fully comply with Sharia law or work well for large banks or the entire banking system. Additionally, they have not eliminated undesirable aspects of interest.

Thus, they have maintained what an Islamic bank should eliminate. Islamic Banking in non-Muslim Countries: The modern commercial banking system in almost all countries worldwide is primarily derived from and patterned after the practices in Europe, particularly in the United Kingdom. The philosophical foundations of this system revolve around the fundamental principles of ensuring capital certainty for depositors and

certainty about the rate of return on deposits. Central Banks have been authorized with the responsibility of enforcing these principles for the benefit of depositors and to guarantee the seamless operation of the banking system.

All banks, including Islamic banks in non-Muslim countries, must adhere to the rules set by the Central Bank. However, Islamic banks face certain challenges in complying with these regulations. In Pakistan, there are several Islamic banks operating, such as Al Faysal Investment Bank Ltd in Islamabad, Al Towfeek Investment Bank Ltd (Dallah Al Baraka Group) in Lahore, Faysal Bank Ltd in Pakistan, National Investment Trust Ltd in Karachi, and Shamil Bank Meezan Bank Limited. Additionally, the National Bank of Pakistan has recently started offering Islamic banking services in the country.

NBP Islamic Banking - OTHER SERVICES
In addition to Shariah acceptable standard general banking services, the Islamic Banking Branch also provides the following services:

• Letter of Credit Facility
• Handling of Remittances
• Issuance of Bank Drafts and Pay Orders
• Collection of Export Bills
• Collection of Local Bills
• Government Collections
• Utility Bills Collection

1. The responsibilities of the Islamic financial portfolios sector include investing the cash waqf efficiently and effectively.

Nazir, a fund manager, will invest the gathered cash waqf in Islamic financial portfolios. Islamic banking and finance are based on the teachings of Prophet Muhammad (P. B. U. H) and the Qur'an, which is known as Islamic Law3. Islamic Law encompasses a set of interrelated rules that prohibit interest-taking and speculative practices.

In general, the portfolios are divided into four types, namely a) Islamic mutual funds, b) Islamic Capital Market Indices, c).

Islamic financial institutions issue various products such as Mudharaba Deposits and Islamic Bonds. The profits earned from these products are distributed to fulfill

the basic needs of the poor and improve their quality of life. Meanwhile, the principal amount is continuously invested in promising investment opportunities.

Is Riba ISLAMIC OR NOT ? The prohibition of Riba has no difference. First, there is building moral resentment against taking Riba. The Riba that you practice, hoping to increase your wealth, does not actually increase in God's consideration. The Verse 30:39 reads: ????? ??????? ??? ???????? ????? ?????? ????? ??????? ????? ??????? ????????? ??? ?????????? ????? ??? ???????? ?????????? ???????????? ?????? ?????? ???? ?????????????? And whatever you lay out as Riba, so that it may increase in the property of (other) people, it shall not increase with Allah; and whatever you give in charity, desiring Allah's pleasure-- it is these (persons) that shall get manifold. Interestingly, this Verse is Makkan; it came several years before the prohibition of Riba.

Secondly, the condemnation of Riba is mentioned as an aspect of Disobedience that leads to earning the anger of God. Referring to previous generations, Verses 4:160-161 state: "Because of their wrongdoing, which they committed, We made certain good and wholesome things unlawful for them that had been lawful for them, and because of their hindering many people from the path of God, and because of their taking usury while they had been forbidden from it..."

Surah al Nisa', which is chapter 4 of the Qur'an, was revealed during the early Medina period when the conflict with the Jewish tribes began. The prohibition of Riba, or usury, was actually revealed after the defeat in the battle of Uhud, which was in the third year of Hijra. This prohibition came about because there were rumors that the

Makkans had used Riba to raise funds for their revengeful battle. The purpose of revealing this prohibition, as stated in verse 3:130, was to uplift the spirits of the defeated and help them rebuild their lives by providing alternative means of raising funds. Therefore, verse 3:130 warns the believers not to engage in devouring Riba, as it leads to increase and multiplication, and instead advises them to be mindful of their duty to Allah in order to prosper.

Those familiar with Arabic rhetoric can determine that the phrase "doubled and multiplied" describes Riba, rather than specifying a particular type or rate for its prohibition. Following the complete prohibition, the final stage emphasizes that Riba is one of the gravest sins in Islam and provides a clear definition on how to eliminate Riba practices from society. This stage includes various verses from the Quran as well as teachings from the Prophet, peace be upon him. Many commentators refer to Riba as "eating other people's property in vanity" and argue that verses 4:29 and 2:188 are about Riba, stating: "O ye who believe! Eat not up your property among yourselves in vanity, except it be a trade by mutual consent." Additionally, they emphasize the importance of not consuming one's property in vanity.

However, the verses that strongly condemn Riba are those of Surah 2, numbers 275 through 280. To take only the relevant sections of these verses, they read: ???????? ???? ?????????? ?? ??????? ??????????? ?????? ???? ?????????? ? ???????????? ?????? ??????? ????? ? ? ? ???? ???????? ?????????? : ??????? ?????? ????????? ??????? ? ???????? ??????? ???????? ????????? ???? ? ?. Those who devour Riba will not stand

except as stands one whom the Evil one by his touch Hath riven to madness; That is because they say: "Sale is just like Riba;" But Allah hath permitted sale and forbidden Riba. And, ???????? ??????????? ????????? ???????? ???? ? ?. Allah will destroy (demolish) Riba, but will give increase for acts of charity. And, ??? ??????????? ?????? ??? ??????? ???? ?????? ??? ????????? ?????? ???????? ???????? ???????? ??????? .

O believers! Fear Allah and give up the remainder of your Riba (usury) if you are truly believers. And if you do not do so, then be prepared for war with Allah and His Messenger. And be warned that if you repent not, there shall be grievous punishment hereafter for you in the tormenting fire. Verily, those who continue with Riba are at war with Allah and His Messenger. Whoever maintains this practice deserves the curse of Allah, the angels, and all of mankind.

. ? But if you repent, you will have your principals; neither will you make the debtor suffer injustice (loss), nor will you be made to suffer injustice (loss). And if the debtor is in difficulty, then let there be postponement to the time of ease. Finally, Verse 282 refers to an alternative deferred payment sale that creates indebtedness: ??? ???????? ?????? ???? ???????? ??????????? ????? ???????? ???????? ??????? ???????????? . . .

O ye who believe, if you engage in dealings involving debt, take note of these points: • Firmly reject the practice of Riba (interest); • Strongly condemn and denounce Riba practices as oppressive and unjust; • Emphasize the seriousness of the sinfulness of Riba, as it is the only

instance in the Qur'an where 'a notice of war from God and His Messenger' is mentioned; • Clearly define any excess over the principal as Riba; • Maintain an unwavering stance against rescheduling with an increase; and finally; • Suggest that deferred-payment sales are an acceptable alternative.

Throughout history, Muslim scholars have universally recognized Riba as prohibited in the Qur'an. Riba refers to any increase in a lending contract, regardless of its size or rate. This unanimous understanding can be attributed to the clear message conveyed in Verse 2:279, which is also reiterated in several Sayings of Prophet Muhammad, pbuh. There are approximately 55 Sayings of acceptable level of authenticity that address the issue of Riba, most of which align with the Qur'anic teachings. While I will refrain from delving into a lengthy discussion on Riba al Fadl (excess usury), it remains an important aspect to consider.

, The topic of Riba in sales is a minor issue, so I will only mention a few Sayings on the Riba of debts, also known as the "Riba of the Qur'an". The most well-known and authentic Hadith on this topic can be found in the Farewell Speech given by the Prophet, pbuh, during Hajj, his final pilgrimage. The Prophet, pbuh, said in this speech: "Vo, every thing of the affair of Jahiliyyah is let fall under my feet, the Riba of Jahiliyyah is let fall, and the first Riba I abolish is the Riba of al Abbas son of Abd al Muttalib, it is discarded, all." (principal and increase). This statement was reported by Muslim. Another version of this Hadith, narrated by Abu Dawud and Tirmidhi, says: "..." .

.

. ????? ???????? ?? ??? ?? ??? ?? ? ??????? ???? ??? ? ?????? ? ?????? ?? ? ??? ????? ???? ?????? ??? ?? ?????? ??? ??? . .

Every Riba of Jahiliyyah is prohibited, so no one should be subjected to unjust losses, and neithershould anyone be allowed to commit injustice. However, the Riba of al Abbas son of Abd al Muttalib is completely eliminated. The following three statements highlight the seriousness of engaging in Riba: