Islamic banking

Islamic banking

Islamic banking

Islamic banks have been a growing feature on the world stage since the 1980s. But many of the principles upon which Islamic banking is based have been commonly used for centuries.

Today, more than two hundred and fifty Islamic financial institutions are now operating worldwide. These include banks that offer conventional services alongside Islamic finance. Countries where Islamic financial institutions are operating include France, Germany, Italy, Luxembourg, the Netherlands and the United Kingdom.

Customers do not have to be Muslim to use Islamic finance products and services such as current accounts, savings accounts and home purchase plans. Islamic banks can offer services through branch networks, postal banking, telephone banking and online banking service.

The basic principle of Islamic banking is the prohibition of riba (interest). It also prohibits investments in alcohol, pork, gambling, pornography and anything else that the Sharia’a (Islamic Law) deems unlawful. Sharia’a scholars approve Islamic banking products and services to ensure they comply with Islamic Law.

The relationship between the bank and the customer is based on sharing risk – and sharing the rewards from the financing and investments made. The returns are based on the amount of profit realised from each transaction.

Some main arrangements in Islamic banking, beyond the prohibition of riba, are:

Ijara
Ijara is a form of leasing. It involves a contract where the bank buys and then leases an item to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance.

Mudaraba
Mudaraba refers to an investment contract between two parties – one who provides the funds and the other who provides the expertise – who agree to the division of any profits made in advance.

Murabaha
Murabaha is a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest. The bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest.

Musharaka
Musharaka means partnership. It involves one person placing capital with another and both sharing the risk and reward. The difference between Musharaka arrangements and normal banking is that the parties can set any kind of profit-sharing ratio, but losses must be proportionate to the amount invested.

Further information:

• Financial Services Authority: Islamic Finance in the UK: Regulation and Challenges

• Institute of Islamic Banking and Insurance

• Islamic Banking Fact Sheet