Islamic Banking and Finance
Overview
Islamic Banking and Finance (IBF) is an intermediary transaction that follows the rukun (pillars) and syarat (conditions) from Shariah perspectives. Since IBF is grounded in the tenets of the Islamic faith, all transactions must be compliant with shariah, based on the teachings of the Qur'an and Al-Sunnah and other secondary sources of Islamic law. The rules that govern commercial transactions in Islamic banking are referred to as fiqh al-muamalat. The basic concept of fiqh al-muamalat are as follows:
“Wealth as a trust & Amanah from Allah swt”
“Promotion of honesty, transparency, justice and fairness”
History of Islamic Banking
The practices of IBF can be traced back to the Medieval era in the Middle East where entrepreneurs started engaging in financial transactions with their European counterparts. Initially, they used the same financial principles as the Europeans. Over time, as trading systems developed and European countries started establishing local branches of their banks in the Middle East, some of the banks adopted the local customs of the region where they were newly established, primarily no-interest financial systems that worked on a profit and loss sharing method.
In the early 1960s, Islamic banking resurfaced in the modern world. Since 1975, many new interest-free banks have opened. While most of these institutions were founded in Muslim countries, Islamic banks also opened in Western Europe during the early 1980s. Today, there are more than 500 banks and 1500 mutual funds that comply with Islamic Principles all around the world.
Public Opinion towards IBF
Salient Features
Islamic Banking and Finance |
Conventional Banking |
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Table: Fundamental salient features that differ the two systems
Difference in Products
Deposit
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IBF |
Conventional Banking |
Deposit |
Savings/Current Account | Savings/Current Account |
Type of contract used |
Wadi’ah Yad Dhamanah |
Not applicable |
Returns |
At the discretion of the bank | Returns (Interest) have been guaranteed |
Islamic bank’s structure deposit products by using Wadi’ah Yad Dhamanah contracts i.e., savings with collateral. Grants or gifts may be given to depositors but subject to the banks’ discretion. As for conventional banks, each account holder is promised a return specific to the savings made. Consequently, usury would occur in the savings account. This is due to the reason that banks borrow money that is saved by customers to carry out their business activities. Any increase in the form of return on the customer’s savings is accounted for as usury from the loan transaction.
Financing
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IBF |
Conventional Banking |
Financing product |
Personal Financing | Personal loan |
Type of contract |
Tawarruq or Bai 'Al-Inah | Loans |
Profit/gain |
Resulting from sales | Resulting from interest/loan transactions |
Amount to be paid | The amount is fixed throughout financing period or reduced/given rebates if the customer pays overall more funding early | The amount changes according to changes in the Base Lending Rate |
Asset Ownership
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Must be owned by the seller |
Not applicable |
Late payment
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Compensation (ta’widh) will be imposed | Penalty in the form of compounding will be imposed |
Type of Insurance |
Takaful |
Conventional |
IBF structures financing by using various Shariah contracts – murabahah, ijarah etc. In contrast to conventional banking where the customer will receive debt as a result of borrowing money from the bank and the profit received by the bank based on the interest rate.
Investment
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IBF |
Conventional Banking |
Investment product |
General investment account/accounts special investment | Fixed deposit
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Type of contract used |
Al-Mudarabah |
Not applicable |
Returns |
Profit-sharing according to an agreed percentage | Interest/Dividends
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IBF uses the concept of real profit and risk-sharing which does not impose a burden on any parties involved. For instance, clients as investors and banks as entrepreneurs share profits while losses will be borne by investors in Mudarabah. This coincides with fiqh, ‘every return is at risk’. In contrast with the conventional investment that promises a fixed return at the starting point of the investment contract, which does not involve an actual partnership between the parties involved. Such fixed return promised is usury/riba’ which is haram.
Islamic Banking and Finance in Malaysia:
Back in 1963, the Pilgrims Management Fund Board of Malaysia (now known as Tabung Haji) was the first Shariah-based institution in Malaysia. In 1983, the establishment of the first Islamic bank; the Bank Islam Malaysia Berhad (BIMB) bring about the development of Islamic banking in Malaysia.
Position of Islamic Banking in Malaysia:
Regulators:
Bank Negara Malaysia (BNM) as the financial and Shariah regulator along with Securities Commission (Suruhanjaya Sekuriti Malaysia “SC”) have worked together to implement various policies to expedite the growth of Islamic banking and finance in Malaysia.
Judicial Body:
According to Practice Direction No 1/2003, the Muamalat Court will hear cases on Islamic Banking and Finance
Islamic Banking and Finance Products by Malaysian Banking Institutions:
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PRODUCT NAMES | CONCEPT | BANKS |
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3 |
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4 |
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AmIslamic Bank |
5 |
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6 |
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7 |
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8 |
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9 |
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10 |
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11 |
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EONCap Islamic Bank |
12 |
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13 |
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14 |
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15 |
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16 |
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17 |
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18 |
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19 |
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Islamic Banking and Finance in Indonesia:
Islamic Law was initially accepted as a philosophical theory in Pancasila (one of the nation’s Pillars). Since 1988, The Presidential Instruction No. 1 of 1991 provided that Islamic Law is accepted as a fundamental rule in Indonesia. Islamic Banking and Finance was first introduced to the nation in 1991 when Bank Muamalat Indonesia was established.
Position of Islamic Banking in Indonesia:
Bodies responsible for Islamic Banking and Finance:
Judicial Body:
Islamic Banking and Finance in Brunei Darussalam:
The initial point of Islamic finance industry in Brunei started when His Majesty the Sultan of Brunei decreed in his royal speech of the importance of establishing Islamic banks as part of fardhu kifayah for a Muslim country such as Brunei itself. The royal speech was made during the meeting of Islamic Religious Council Meeting (Majlis Ugama Islam) on 25th September 1990. The industry was then initiated when Tabung Amanah Islam Brunei (TAIB) was established on 29th September 1991 as a trust fund to provide facilities for Muslims there to make pilgrimage to Mekah. TAIB was officially launched by His Majesty Sultan Haji Hassanal Bolkiah Mu’izzaddin Waddaullah ibni Al-Marhum Sultan Haji Omar ‘Ali Saifuddien Sa’adul Khairi Waddien, the current Sultan and Yang Di-Pertuan of Brunei. It was the first institution that conduct all its activities in accordance with Islamic beliefs.
Legal Position of Islamic Banking in Brunei Darussalam:
Bodies responsible for Islamic Banking and Finance:
Judicial Body:
Section 2(3) of Pawnbrokers Order, 2002 recognises the function of Syariah Courts to interpret and resolves any issues relating to Islamic banking. The Courts include Syariah Subordinate Court, Syariah High Court and Syariah Appeal Court, per Syariah Court Act (Ch 184).
Islamic Banking and Finance in Australia:
Islamic banking and finance in Australia are relatively new in the country. The initial attempt in introducing the system was made by the Muslim Community Co-operative Australia (MCCA). Nonetheless, the MCCA, the Muslim Community Credit Union Ltd (MCCU) and Hejaz Financial Services are now on the way to becoming full-fledged Islamic institutions. The establishment of these organizations was made in response to the growth of Muslims in the country while simultaneously catering to the needs of the community.
Fundamentally, the expansion of Islamic banking and finance there has been slow due to numerous reasons. However, several other organizations have been established to further strengthen the Islamic banking and financial system in the banking industry. For instance, Islamic Co-operative Finance Australia Limited (ICFAL) and Iskan Finance provide for Islamic finance facilities. There are also Crescent Investments and LM Investment offering Islamic fund management to the Islamic community there.
Bodies Responsible for Islamic Banking and Finance:
Islamic Banking and Finance in the United Arab Emirates:
The establishment of the Dubai Islamic Bank (DIB) has become the initial point of the development of Islamic banking and finance all around the world. DIB being the world’s first Islamic commercial bank was established by the UAE’s government with the view to introduce full-fledged Islamic banking and finance into the financial system. The vision was successfully achieved when Sharjah Islamic Bank, or formerly known as National Bank of Sharjah, was the first bank in the world to be converted from a conventional bank to an Islamic bank in 2002. To date, the nation has triumphantly established more than five (5) full-fledged Islamic banks with 20 others practicing Islamic financial systems and products.
Position of Islamic Banking in UAE:
Bodies Responsible for Islamic Banking and Finance:
Glossary
Bai Dayn
A transaction involving a debt-trading contract.
Bai Bithaman Ajil
A sale where payment is deferred in installments or in full over a specified period and date.
Bai 'Al-Inah
A transaction of sale and buy-back contract.
A seller sells an asset to the buyer and subsequently buys back the asset at a deferred price which is higher than the sale price or the seller sells an asset at a deferred price and later buys back the asset at a lower price than such deferred price.
Bai ’Al-Sarf
A contract that involves buying and selling a currency with points of money of the same kind or of different kinds.
Gharar
A form of uncertainty. A yet-to-be form of transaction.
Hibah
A gift or consideration that involves a party to transfer the ownership of his asset to another.
Ijarah
A rental contract involving interest/benefits from an asset with a certain payment within an agreed period.
Ijarah Thumma Al Ba’i
A transaction that is based on the principles of lease followed by sale. Here, the applicant should pay an agreed rental payment over a specific period during the leasing contract.
Istisna'
A transaction of sale and purchase by order for a product with specifications and by a method of delivery and payment either cash or deferred payment.
Kafalah
A transaction involving any form of guarantee provided by the guarantor to a third party on the obligations that must be fulfilled by the party insured/guarantee.
Mudarabah
A partnership contract that involves an agreement between investors and fund managers to share profits by ratio to a particular partnership where losses will be borne entirely by the investor.
Murabahah
A transaction of sale and purchase that involves the cost price of the asset and the rate profits which are clearly stated to the buyer.
Musyarakah
A partnership contract that involves an agreement jointly by a business partner to share any profits or the resulting losses.
Musyarakah Mutanaqisah
A transaction that allows the partner of the agreement to lease his share of musyarakah asset to other partners.
Rahnu
A transaction that involves the lien of an intended asset loan money by handing over goods as collateral for a certain period.
Sukuk
Sukuk is a trust certificate whereas a bond is a contractual debt obligation. Generally, Sukuk represents a beneficial ownership interest in the underlying asset. Returns on Sukuk are tied to the returns earned through the underlying assets. For bond, the issuer is contractually obliged to pay bondholders, on certain specified dates, interest and principal.
Tawarruq
A transaction that involves the purchase of an item with a deferred price, then selling it to a third party to earn cash.
Ta’widh
A compensation or fine imposed by banks due to late payment.
Wadiah
A contract that involves storing an item or property as a trust.
Wadi’ah Yad Dhamanah
Savings with collateral e.g., the property is being deposited based on trust
Wakalah
A transaction involving the appointment of a representative/agent to execute a transaction, and in return, the representative will receive wages for such services.
Fardhu Kifayah
A form of legal obligation that must be discharged by the Muslim community.