Islamic Banking

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Islamic banking 1 Islamic banking Islamic banking (or participant banking) (Arabic: ‫ )ﺍﻟﻤﺼﺮﻓﻴﺔ ﺍﻹﺳﻼﻣﻴﺔ‬is banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Riba or usury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic pri
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  Islamic banking1 Islamic banking Islamic banking (or participant banking ) (Arabic: ﺔﻴﻣﻼﺳﻹﺍ ﺔﻴﻓﺮﺼﻤﻟﺍ ) is banking or banking activity that is consistentwith the principles of Islamic law ( Sharia ) and its practical application through the development of Islamiceconomics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Riba orusury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamicprinciples is also Haraam (forbidden). While these principles may have been applied to historical Islamic economies,it is only in the late 20th century that a number of Islamic banks were formed to apply these principles to private orsemi-private commercial institutions within the Muslim community. [1][2] History of Islamic banking Introduction An early market economy and an early form of mercantilism were developed between the 8th-12th centuries, whichsome refer to as Islamic capitalism . [3] The monetary economy of the period was based on the widely circulatedcurrency the gold dinar, and it tied together regions that were previously economically independent.A number of economic concepts and techniques were applied in early Islamic banking, including bills of exchange,partnership ( mufawada ) such as limited partnerships ( mudaraba ), and forms of capital ( al-mal ), capital accumulation( nama al-mal ), [4] cheques, promissory notes, [5] trusts (see Waqf  ), [6] transactional accounts, loaning, ledgers andassignments. [7] Organizational enterprises independent from the state also existed in the medieval Islamic world,while the agency institution was also introduced during that time. [8][9] Many of these early capitalist concepts wereadopted and further advanced in medieval Europe from the 13th century onwards. [4] Riba The word Riba means excess, increase or addition, which according to Shariah terminology, implies any excesscompensation without due consideration (consideration does not include time value of money). The definition of  riba in classical Islamic jurisprudence was surplus value without counterpart , or to ensure equivalency in realvalue , and that numerical value was immaterial. Applying interest was acceptable under some circumstances. Currencies that were based on guarantees by agovernment to honor the stated value (i.e. fiat currency) or based on other materials such as paper or base metalswere allowed to have interest applied to them. [10] When base metal currencies were first introduced in the Islamicworld, the question of paying a debt in a higher number of units of this  fiat  money being riba was not relevant asthe jurists only needed to be concerned with the real value of money (determined by weight only) rather than thenumerical value. For example, it was acceptable for a loan of 1000 gold dinars to be paid back as 1050 dinars of equal aggregate weight (i.e., the value in terms of weight had to be same because all makes of coins did not carryexactly similar weight)....  Islamic banking2 Modern Islamic banking (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborateexposition by Mawdudi in 1950. The writings of Muhammad Hamidullah 1944, 1955, 1957 and 1962 should beincluded in this category. They have all recognised the need for commercial banks and their perceived necessaryevil, have proposed a banking system based on the concept of Mudarabha - profit and loss sharing.In the next two decades interest-free banking attracted more attention, partly because of the political interest itcreated in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted tothis subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969),al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.The early 1970s saw institutional involvement. The Conference of the Finance Ministers of the Islamic Countriesheld in Karachi in 1970, the Egyptian study in 1972, the First International Conference on Islamic Economics inMecca in 1976, and the International Economic Conference in London in 1977 were the result of such involvement.The involvement of institutions and governments led to the application of theory to practice and resulted in theestablishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process. [11] The first modern experiment with Islamic banking was undertaken in Egypt under cover without projecting anIslamic image  — for fear of being seen as a manifestation of Islamic fundamentalism that was anathema to thepolitical regime. The pioneering effort, led by Ahmad Elnaggar, took the form of a savings bank based onprofit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967 (Ready 1981), bywhich time there were nine such banks in country. [12] In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, currently, is still in business inEgypt. In 1975, the Islamic Development Bank was set up with the mission to provide funding to projects in themember countries. [13] The first modern commercial Islamic bank, Dubai Islamic Bank, opened its doors in 1975. Inthe early years, the products offered were basic and strongly founded on conventional banking products, but in thelast few years the industry is starting to see strong development in new products and services.Islamic Banking is growing at a rate of 10-15% per year and with signs of consistent future growth. [14] Islamic bankshave more than 300 institutions spread over 51 countries, including the United States through companies such as theMichigan-based University Bank, as well as an additional 250 mutual funds that comply with Islamic principles. It isestimated that over US$822 billion worldwide sharia-compliant assets are managed according to The Economist. [15] This represents approximately 0.5% of total world estimated assets as of 2005. [16] According to CIMB GroupHoldings, Islamic finance is the fastest-growing segment of the global financial system and sales of Islamic bondsmay rise by 24 percent to $25 billion in 2010. [17] Addressing the Oman Investment Forum in October 2011, all conventional banks in Oman can offer Sharia-basedfinancial services upon approval from the Central Bank of Oman (CBO). [18] The Vatican has put forward the idea that the principles of Islamic finance may represent a possible cure for ailingmarkets. [19]  Islamic banking3 Largest Islamic banks Shariah-compliant assets reached about $400 billion throughout the world in 2009, according to Standard & Poor ’ sRatings Services, and the potential market is $4 trillion. [20][21] Iran, Saudi Arabia and Malaysia have the biggestsharia-compliant assets. [22] In 2009 Iranian banks accounted for about 40 percent of total assets of the world's top 100 Islamic banks. Bank MelliIran, with assets of $45.5 billion came first, followed by SaudiArabia's Al Rajhi Bank, Bank Mellatwith $39.7 billion and Bank Saderat Iran with $39.3 billion. [23][24] Iran holds the world's largest level of Islamic finance assetsvalued at $235.3bn which is more than double the next country in the ranking with $92bn. Six out of ten top Islamicbanks in the world are Iranian. [25][26][27] In November 2010, The Banker published its latest authoritative list of theTop 500 Islamic Finance Institutions with Iran topping the list. Seven out of ten top Islamic banks in the world areIranian according to the list. [28] Principles Islamic banking has the same purpose as conventional banking: to make money for the banking institute by lendingout capital. Because Islam forbids simply lending out money at interest (see riba), Islamic rules on transactions(known as  Fiqh al-Muamalat  ) have been created to avoid this problem. The basic technique to avoid the prohibitionis the sharing of profit and loss, via terms such as profit sharing (  Mudharabah ), safekeeping ( Wadiah ), joint venture(  Musharakah ), cost plus (  Murabahah ), and leasing (  Ijar  ).In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy theitem itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank ininstallments. However, the bank's profit cannot be made explicit and therefore there are no additional penalties forlate payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land isregistered to the name of the buyer from the start of the transaction. This arrangement is called  Murabahah .Another approach is  EIjara wa EIqtina , which is similar to real estate leasing. Islamic banks handle loans forvehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownershipof the vehicle until the loan is paid).An innovative approach applied by some banks for home loans, called  Musharaka al-Mutanaqisa , allows for afloating rate in the form of rental. The bank and borrower form a partnership entity, both providing capital at anagreed percentage to purchase the property. The partnership entity then rents out the property to the borrower andcharges rent. The bank and the borrower will then share the proceeds from this rentbased on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank's share of the propertyat agreed installments until the full equity is transferred to the borrower and the partnership is ended. If defaultoccurs, both the bank and the borrower receive a proportion of the proceeds from the sale of the property based oneach party's current equity. This method allows for floating rates according to the current market rate such as theBLR (base lending rate), especially in a dual-banking system like in Malaysia.There are several other approaches used in business transactions. Islamic banks lend their money to companies byissuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return.Thus the bank's profit on the loan is equal to a certain percentage of the company'sprofits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called  Musharaka . Further,  Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamicview that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income andnot allowing the lender to monopolize the economy.Islamic banking is restricted to Islamically acceptable transactions, which exclude those involving alcohol, pork,gambling, etc. The aim of this is to engage in only ethical investing, and moral purchasing. The Islamic Banking and  Islamic banking4Finance Database provides more information on the subject. [29] In theory, Islamic banking is an example of full-reserve banking, with banks achieving a 100% reserve ratio. [30] However, in practice, this is not the case, and no examples of 100 per cent reserve banking are observed. [31] Islamic banks have grown recently in the Muslim world but are a very small share of the global banking system.Micro-lending institutions founded by Muslims, notably Grameen Bank, use conventional lending practices and arepopular in some Muslim nations, especially Bangladesh, but some do not consider them true Islamic banking.However, Muhammad Yunus, the founder of Grameen Bank and microfinance banking, and other supporters of microfinance, argue that the lack of collateral and lack of excessive interest in micro-lending is consistent with theIslamic prohibition of usury (riba). [32][33] Shariah Advisory Council/Consultant Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required toestablish a Shariah Supervisory Board (SSB) to advise them and to ensure that the operations and activities of thebanking institutions comply with Shariah principles. On the other hand, there are also those who believe that no formof banking that involves interest payments can ever comply with the Shariah. [34] In Malaysia, the National Shariah Advisory Council, which has been set up at Bank Negara Malaysia (BNM),advises BNM on the Shariah aspects of the operations of these institutions and on their products and services. (See:Islamic banking in Malaysia). In Indonesia the Ulama Council serves a similar purpose.A number of Shariah advisory firms have now emerged to offer Shariah advisory services to the institutions offeringIslamic financial services. Issue of independence, impartiality and conflicts of interest have also been recentlyvoiced. The WDIBF World Database for Islamic Banking and Finance has been developed to provide informationabout all the websites related to this type of banking. [29] Islamic Financial Accounting Standards The Institute of Chartered Accountants of Pakistan issues Islamic Financial Accounting Standards (IFAS) for IslamicMode of financing. IFAS 1 (issued in 2005) concerns Musharakah and Mudarabah. While, IFAS 2 (issued in 2007)relates to Ijarah. Fundamentals of Islamic finance The term “ Islamic banking ” refers to a system of banking or banking activity that is consistent with Islamic law(Shariah) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection andpayment of interest, also commonly called riba in Islamic discourse. In addition, Islamic law prohibits investing inbusinesses that are considered unlawful, or haraam (such as businesses that sell alcohol or pork, or businesses thatproduce media such as gossip columns or pornography, which are contrary to Islamic values). Furthermore theShariah prohibits what is called Maysir and Gharar . Maysir is involved in contracts where the ownership of agood depends on the occurrence of a predetermined, uncertain event in the future whereas Gharar describesspeculative transactions. Both concepts involve excessive risk and are supposed to foster uncertainty and fraudlentbehaviour. Therefore the use of all conventional derivate instruments is impossible in Islamic banking. [35] In the late20th century, a number of Islamic banks were created to cater to this particular banking market.
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