Islamic Banking What You Should Know

ISLAMIC BANKING

Islamic banking refers to banking activities that Adhere to shariah (Islamic law). The full-fledged system of Islamic banking was introduced in

The 1960s by an Egyptian bank ‘Myt Ghamr‘.

Two things that are peculiar to Islamic banking

are the sharing of profit and loss, and the

Non-collection and payment of interest by lenders

and investors. The precepts of Islamic banking are

derived from the Qur’an–  the sacred scripture of Islam.

In Islamic banking, all transactions must follow the laws

of shariah, the legal code of Islam

(based on the teachings of the Qur’an). The rules that

govern Business transactions in Islamic banking are

referred to as Fiqh al-muamalat. The transaction

under Sharia law must meet six basic principles (Lepeshkina, 2013):

1. The interest is prohibited (“rhiba“);
2. The risk should be shared;
3. The speculative behavior is prohibited (“maysir“);
4. Use of asymmetric information is banned (“gharar“);
5. The contracts should be respected;
6. Trade transactions allowed by Islamic norms should be financed only.

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One of the primary differences between conventional banking systems and Islamic banking is that Islamic banking prohibits lending at interest.  Islamic bank makes a profit through equity participation, which requires a borrower to give the bank a share in their profits rather than paying interest. In addition, any investments involving product or commodity that are prohibited in the Qur’an–e.g. alcohol, gambling are also prohibited.

Recent experience has shown that the interest

of people in Islamic Banking goes beyond only

Islamic investors. ‘’ Islamic finance is reinforcing

the UK’s position as a global financial hub, says

Amir Firdaus, the chief financial officer of the UK’s

an oldest and largest Islamic bank, Al Rayan Bank’’,

yet only 5.1% of its population are Muslims.

The ethnic composition of British Muslim 2011 census

Today, more than 20 banks in the UK offer Islamic services, and five of these banks are fully Sharia-compliant, including Al Rayan Bank. Al Rayan Bank is the first bank in the world to issue a public sterling sukuk (Islamic bond) in a non-Muslim country.  In view of this, governments and regulators in some countries Nigeria inclusive have already recognized the importance of Islamic Banking as a feasible alternative to Conventional Banking.

Islamic banking in Nigeria began in January 2012, when the Central Bank of Nigeria granted Jaiz Bank a license to operate as a regional interest-free bank in northern Nigeria. As a result, Jaiz bank became the first and the only full-fledged Islamic bank in Nigeria.

SPECIFIC FORMS OF ISLAMIC BANKING

1. Musharakah: It is a joint implementation of a project by the bank and an entrepreneur. All partners contribute capital and share the profit and loss on a pro-rata basis.

1. Mudarabah: It is an agreement according to which a client of a bank transfers money to the bank for the subsequent investment of this money into a certain project or type of activity. The profit received during the implementation of the project is divided in a specified proportion.
2. Murabaha: It involves the bank acquiring a certain product for resale. The bank takes over the organization of sales, storage, transportation, e.t.c. For example, the bank acquires goods at its own expense for a customer’s order, the bank bears the entire risk of the trading operation resells the goods to the customer at a price that includes the extra charge stipulated in the contract. This percentage or extra charge becomes the income of the bank.

CHALLENGES FACING ISLAMIC BANKING

Islamic banks are essentially governed by their Shari’a boards – the religious scholars that deem a product Shari’a-compliant. But the challenge is that there is no central authority promulgating Shari’a law, and the understanding of what is hence permissible and what is not varies among Islamic scholars and jurisdictions.

The rapid growth of Islamic banking over the years has resulted in the introduction of complex banking products and structures, which now require Shari’a harmonization at a global level. At present, that harmonization is lacking. While conventional banks have harmonized and approved regulatory standards that banks around the world follow, making it easier for them to expand and conduct operations in different countries, there are no approved standards per se for Islamic banks.