Islamic Banking&Finance

Introduction:

Let me briefly explain the principles of Islamic Finance and Banking, it means that we conduct business in a Shari’a compliant manner. Shari’a again is Islamic law, that derives its rulings from the Muslim holy book Qur’an and the Sunnah of the Prophet Muhammad pbuh, which is his sayings and actions. The most important thing to remember when we are speaking about Islamic Finance is that it is forbidden in Shari’a to involve yourself in interest, usury, gambling and other things deemed unpermissable . It’s clearly stated in the Qur’an:

“Oh those who believe, fear Allah and give up what still remains of the interest if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger…” [2:278-279]

But one thing we have to understand is that trade is permissible and it’s not to be confused with the business of interest. So the trading in money is not allowed, meaning: Money is used as a measurement of value of a product, it is not an asset in itself.

Business deals also have to be completely transparent, if a deal is going to be signed then both parties have to be fully aware of all costs and obligations etc. For example, my father once told me to participate in a lottery with my cell phone by sending a text message, after sending it they started charging me for 20-30€ per month for some messenger program that I would never use. It was not stated anywhere that I would have to start paying this sum of money, this deal would hence have been deemed invalid in Shari’a and the company, that was deceiving the customer in this case me, would have been punished. Not to mention that it was lottery which is considered gambling in Shari’a which in itself is unlawful. Also, trading in businesses which are unlawful, such as alcohol or tobacco is not allowed.

The Islamic system also makes people think more on society rather than themselves and it transfers with the “Zakat” system, which means almsgiving, money from the rich to the poor. Any Muslim that has about 85 grams of pure gold which is about 1700€ of savings or capital is obliged to pay 2.5% of all his wealth to the poor annually.

So back to the core issue Finance& Banking. When people hear that Islamic banks are not allowed to involve themselves in the business of interest, everyone including most Muslims become very confused, we are brought up with the idea that the only way a bank can survive is with interest, but this of course is not true. Even the banks we are used to get a large part of their profits from interest free investments.

So how is it that the Islamic banks give out loans and actually generate a profit?

The Islamic Bank of Dubai reported a $304.9 million profit for the 9 first months of this year but how do they do it? This is where the Islamic modes of financing come in.

Islamic modes of Financing:

• Musharakah-Active Partnership
• Mudarabah-Partnership
• Murabahah-Sale

This might be a bit confusing for some people because Arabic terms will be used, but I will explain the meanings of these terms as I go on, it’s very important that these words are being used because these are the “real” terms.

1.Musharakah-Active Partnership

The actual word means “Sharing” and in business and trade it means that all the partners in a deal share the profit or loss.

Musharakah can be used when a company wants to invest in something and they don’t have enough own capital to do it. When they sign a Musharakah contract with an Islamic bank it means that the company will invest some of their money and the bank invests the rests and the two parties split the profit or loss according to a agreed ratio. So if a Musharakah deal is signed and the company invests $10 Million and the Bank $90 Million, the split on the profit or loss would usually be 10/90, other ratios can also be mutually agreed upon.

The way this differs from a conventional, interest bearing loan is that firstly the Islamic bank only gets money if the investment is profitable, the conventional gets its interest money either way. So the Bank is actually interested if the investment will bring in money or not. Secondly the interest bearing loan is viewed as unfair to either the debtor or the creditor. If the investment makes a huge profit the creditor still only receives the interest percentage and if the investment actually suffers loss then it’s unfair upon the debtor who still has to pay the interest and he might have to declare bankruptcy.

2.Mudarabah-Passive Partnership

Mudarabah is a agreement that is signed by two partners, a so called “rabb-ul-mal” and a “mudarib”

The “rabb-ul-mal” is the one who provides the capital and the “mudarib” the one who provides the work. The difference to “Musharakah” is that in this type of deal the investor “rabb-ul-mal” does not have a right to interfere with the management or the work, this is only done by the “mudarib”. This is why it’s called Passive Partnership. The ratio of the profit will be agreed before signing the contract, but in this deal there is no splitting of the loss, since only one party invests capital. The loss for the other party is that he will not have a job.

A good example of this is that one friend of mine wanted to open a electronics shop in my town, but he did not have the required capital to start the business so me and my friend thought that we could provide the capital and he would do the actual work and we would split the profit in a agreed manner. This is what Mudarabah is in a practical example. Unfortunately we have not signed the Mudarabah contract since we are poor students and lack the willpower.

3. Murabahah-Sales contract

Murabahah is the simplest of the Islamic modes of financing and some may even debate that it does not belong to the financing category. What Murabahah means is that a party does not have enough capital to buy something so the Islamic bank buys the product and sells it to the party with an increased price. So it’s a simple Sales contract. So if you don’t have money to buy a car worth $5000 I can buy the car and sell it to you for $5500. You will receive the ownership instantly but the payment can be transferred at a later date as agreed upon. That is Murabahah in a practical everyday situation. Some people might now say that this is the same as interest when it in reality is not, according to Shari’a, in Murabahah you are indeed increasing the sum of a product, but you are paying an increased sum on the actual product and not on money like you do in an interest bearing deal.

Islamic Mortgage:

Islamic Mortgage is when you buy a house in a Shari’a compliant manner, so as always no interest is allowed. The way to do this is with the so called Diminishing Musharakah, this means that the party that wants to buy a house will come up with 10-20% (usually) of the sum and the Islamic bank will invest the rest.

So if you want to buy a $300.000 worth house you invest $60.000 and the bank the remaining $240.000, and during a fixed time, let’s say 20 years you will pay back to the bank the sum that they invested and you will also pay a rent for the house, which is measured according to how much more you have to pay to the bank. So if the house you pay would normally have a rent of $1000 per month, and you already came up with 20% of the sum, then you will be paying $800 per month to the bank as rent, and as you pay off your loan the rent decreases.

Charitable loans:

The Islamic banks also give out so called, charitable loans to people in need. In this type of loan the debtor only pays back the loan and no increase. These loans can be issued to for example students.

Conclusion:

Some of the modes of financing are not what the Islamic banks are striving for, they are merely a step in the right direction, and although they are Shari’a compliant they are not the goal that they are striving for. We also have to remember that the current Islamic Finance is only about 35 years old, so it is indeed a very young branch and it is constantly being improved. The industry suffers a lot of challenges when the whole world is run on interest, but some countries have already changed their economics system. Countries like Sudan, Iran and Pakistan have succeeded in this. Even some Western banks such as Deutche Bank and HSBC have also opened Shari’a compliant branches. I hope that people have benefitted from this presentation and maybe it opened the eyes for some to understand that the interest bearing system is not the only one in this world, there is an alternative.

Is working in Bank forbidden (HARAM) in Islam? Dr Israr Ahmad

Islamic Economy and Interest free Banking Shaykh ul Islam Dr.Tahir ul Qadri

Islamic Finance – A False Dawn

Open up the pages of any newspaper or Financial Magazine and you are guaranteed to find advertisements from banks announcing their latest Islamic finance products. Once perceived as a niche market, Islamic finance today is big business with both local and international banks keen to get in on the act. An increasing number of non-Muslims are adopting Islamic compliant products as awareness of the principles behind Shari’ah finance has grown. In 2008, at least $500 billion in assets around the world were managed in accordance with Shari’ah and the sector is growing at more than 10% per year.

Asif Mumtaz, regional head of HSBC Amanah, HSBC's Islamic banking arm, says: "Within this region the Islamic finance industry is evolving from a niche segment to a mainstream one. "It is our informed opinion that within the next eight to 10 years, the industry will capture half of the savings of l.6 billion Muslims worldwide."

To gain a foothold in the market many conventional banks, including HSBC have launched Islamic versions of their traditional products - including Islamic loans and credit cards. In recent weeks Standard Chartered announced the launch of its global Islamic banking brand in the Middle East, Saadiq and its first Islamic credit card, the Saadiq Gold Credit Card. It followed hot on the heels of First Gulf Bank's first Islamic credit card the Meccah Credit Card, which rewards customers with the opportunity to earn steps to travel to the Holy City of Mecca.

Islamic Finance and the West

In the West London is turning into a hub for Islamic financial activity, Gordan Brown announced changes to the tax status of Islamic finance in his 2006 budget. Then on the 23rd April The British government announced it will issue Islamic bonds, seeking to meet what it believes is a significant demand for this financial product both inside and outside the UK. The evolution of Islamic finance has resulted in Ford Motor Inc selling Aston Martin - maker of James Bond's favourite sports car for £479 million ($1.2 billion) to a leveraged buy-out (LBO) consortium organized through Islamic Finance.

Britain currently has five Islamic banks, whilst at the same time Britain’s high street Banks offer a range of products which they claim are Shari’ah compliant. The Islamic Bank of Britain offers a Shari’ah compliant current account, mortgage and personal loan. HSBC offers an Islamic current account and mortgage. A handful of other banks - including some of the biggest international names and the Middle East's biggest traditional banks - also offer financial products in the UK.

Whilst Islamic finance and Economics has been welcomed with open arms by some, there are some who are sceptical. Islamic finance is sparking a heated debate in France, a strictly secular European heavyweight, though economists contend it would be in the country’s interest to tap into the booming global industry. The French parliament in September approved a number of adjustments to its banking laws to allow sukuk (Islamic bonds) to be issued for the first time. This was at the same time as the Qatar Islamic Bank applied for license to operate in France as the first Islamic bank. However Socialist MP Henri Emmanuelli told Agence France Presse (AFP) that "We must not allow principles of Shari`ah law, or the ethics of the Qur`an to be introduced into French law." This has led to France's highest constitutional authority on October 14th to strike down some of the provisions the French Parliament passed.

Islamic banking: The basics

The main difference according to the industry between a banks' conventional and Islamic products is the absence of interest. Under Shari’ah law interest, whether nominal or excessive, simple or compound, fixed or variable is forbidden. Shari’ah based products also favour asset-based transactions.

Explaining the principles behind it Dr Taha El Tayeb, head of products development and Sharia structuring at Mashreqbank's Islamic banking division Badr Al-Islami says: "Islamic finance and Sharia law would always recommend people to go for asset-based transactions. If you need to buy a car for instance, instead of borrowing money from a bank - that bank should take the risk, buy the car and sell it to you at a profit rate." he also adds: "The intent of Islamic banking is very much that you are in a socially responsible banking community. Islamic banking moves away from pure speculation and more into activities that will help to grow the industry and the infrastructure-based economy. Every transaction is tied to an asset, which is a real world economy asset." There are three main Islamic financial instruments which are used to structure Islamic loans.

Ijara works as a leasing agreement whereby the bank buys an item - such as a house or a car - for a customer then leases it back to them until they have paid off the full amount and take over ownership of the item. "When a customer is planning to buy something we at Amlak buy that property then we give it to the customer on a lease period of 15 to 20 years then the ownership passes to the client. There is no interest charged but there is profit based on the fact that when you own a property you have the right to rent it out for however much you want." Says Khalid Zainal, Director of Sales and Marketing of Amlak Finance

Murabaha works by the bank supplying specific goods for resale to the customer at a profit rate. The customer pays the bank back in monthly instalments - the rate of which are fixed. Commodity Murabaha is designed for customers who want a fixed rate cash loan and involves the purchase and sale of commodities on the London Metal Exchange.

The third Islamic banking instrument, Musharaka, which is a joint venture whereby the customer and bank contribute to the funding of a venture and agree to share the returns - as well as the risks - in proportions agreed in advance.

Islamic credit cards look set for major growth with increasing demand from customers prompting banks such as Standard Chartered and First Gulf Bank to launch their own Sharia compliant products. However Islamic credit cards are still to hit the western high street. Islamic credit cards work in much the same way as conventional cards but in place of interest banks will charge customers annual or quarterly fees. Standard Chartered's latest offering, the Saadiq Visa Gold Credit Card, for example operates on the Urjah concept, which is based on a fixed fee structure.
Customers are given a grace period to pay the monthly outstanding balance on the card to avoid paying a fee, and a fixed monthly maintenance fee is charged for usage of the card's service account.

Islamic Economics

The global financial crisis has highlighted some fundamental problems with free market economies. The market as the ideal method to distribute wealth has been discredited, economic growth in free market economies has proven to be unsustainable and the financial markets, for long the showpiece of free market success has proven to be no different to a casino.

In order to stimulate many of the broken economies of the West and overcome many of the structural flaws that cause economic crisis, many free market governments have turned to Islamic finance due to the phenomenal growth it has shown in the last decade. However this deflects attention from the real problems the West faces.

Whilst there is much the West can learn from the Islamic economy – such as the stability Islam brings by being based upon the real economy, the rapid distribution of wealth through a non-interest based economy and the stability Islam’s provided by Islam’s trade rules and the removal of gambling and speculation. Such economic concepts are in reality a few aspects of the Islamic economy, which itself are built upon a fundamental alternative view towards wealth, production, the macroeconomy and property. The mere adoption of some aspects of Islam will not solve the economic problems of the West and even the Muslim world.

Free market economies need a complete overhaul as no amount of regulation will ever curb the motive to make money at any cost. For this reason boom and bust has been a feature of free market economies for over 200 years and will continue to do so.

Conclusions

The Islamic economic system is an integrated system with different aspects of Islamic economics all feeding into each other. The rules of Riba are built upon Islam’s view of wealth, the Islamic rules of trade are built upon Islam’s view towards ownership, Islamic taxation is built upon Islam’s views towards wealth distribution and Islamic finance is built upon Islam’s view towards investment and currency. Taking a part of Islam without its framework will only create contradictions in an economy. Attempts by the West to plug its problems through aspects of Islam are attempts at giving the free market a leg up.

The Ummah should not feel happy when a few elements of Islamic economics are made available. This is an implicit acceptance that Islam can not stand on its own feet. There is a much bigger issue and that is why are the Gulf states and the Far East who are the leaders in Islamic finance not comprehensively implement Islam and make it available in the Muslim world. Such an approach would completely revitalise the economies of the Muslim world and project a positive image of an economic alternative. Islam is a complete system, all of it should be applied