Islamic Banking BS7
Islamic Banking BS7
Islamic banking operates on principles that align with Shariah law, emphasizing ethical investments,
avoiding interest (riba), and promoting risk-sharing. Here’s a list of common modes of investment in
Islamic banking:
1.Mudarabah (Profit-Sharing)
A partnership where one party provides capital, and the other offers expertise and management. Profits
are shared based on a pre-agreed ratio, while the loss is borne only by the capital provider.
4.Ijarah (Leasing)
Similar to conventional leasing, the bank buys an asset and leases it to the client for a fixed rental
payment. Ownership remains with the bank, but at the end of the lease, there’s an option to transfer
ownership to the client.
2. Allows and depends heavily on interest as a key element of the financial system. Interest is seen as the
cost of borrowing, with lenders earning a return on their capital based on time and risk.
3. Primarily uses debt-based financing where risk is transferred to the borrower. Lenders receive fixed
returns regardless of the outcome of the investment, creating a separation between financial rewards
and real economic productivity.
4. Investment decisions are usually guided by profitability and risk-reward balance. While ethical
investment options exist, they are often secondary to the profit motive, and not all sectors are restricted.
5. Generally aims for profit maximization, efficiency, and growth. Success is often measured by GDP,
corporate profits, and shareholder value, with less emphasis on social and ethical outcomes.
2.: Prohibits riba (interest) entirely, as earning money from money alone is considered exploitative.
Instead, it promotes risk-sharing and trading activities that contribute to economic development.
4. Investments must align with Shariah principles, meaning they cannot fund activities or industries
considered harmful, such as alcohol, gambling, and weapons manufacturing. Ethical investment is a core
component, aiming for societal and environmental well-being.
5. The primary objective is to fulfill human needs and ensure economic justice, rather than just
generating profit. Economic activities are seen as a way to serve society and enhance welfare while
abiding by moral principles.
Example: Two individuals agree to jointly purchase a property as an investment. They both contribute
financially and share ownership of the property voluntarily.
Characteristics:
2.Terms and conditions, including each party’s share and profit-sharing arrangements, are agreed upon
in advance.
Debt Settlement: Any debts or obligations of the Musharakah are settled before the remaining assets
are divided.
Distribution of Assets: After debts are settled, the remaining assets are distributed among the
partners in proportion to their respective shares.
1. Mutual Agreement
The partners in the Musharakah can agree to terminate the partnership at any time by mutual consent.
This is the most straightforward way of ending the agreement.
Here’s a breakdown of how Ijara wa Iqtina works and its main components:
Lease Agreement: The Islamic bank buys an asset (such as a property, car, or equipment) and leases it to
the client for an agreed period at a fixed rental payment.
Ownership: Throughout the lease term, the bank retains ownership of the asset, while the client enjoys
the usage rights.
Promise to Own: Unlike a regular lease, Ijara wa Iqtina includes a clause that allows the lessee to acquire
ownership of the asset at the end of the lease term.
Transfer of Ownership: Ownership can be transferred in one of three ways, depending on the agreemen.
Lease Period and Payments: The customer pays monthly lease payments to the bank for an agreed
period (e.g., 10 years).
In Islam, land refers to natural resources like land itself, water, minerals, forests, and other resources
that Allah has provided.
Definition: Labor refers to the physical and intellectual efforts of individuals in the production process.
Islam highly values labor, viewing it as a noble way to earn a livelihood.
Definition: Capital in Islam includes money, equipment, machinery, and other assets that are used to
generate wealth and facilitate production. However, unlike conventional economics, Islam places strict
conditions on capital utilization.
Entrepreneurship refers to the skills, creativity, and risk-taking ability needed to combine the other
factors of production and manage a business or project.
The asset's ownership remains with the lessor throughout the lease period. Consequently, any risks
associated with ownership (such as wear and tear or loss due to unforeseen events) must be borne by
the lessor.
2. Lease Object
The asset must be clearly defined and known to the lessee. It should exist and be in the lessor's
possession or control at the time of the Ijara agreement.
3. Purpose of Use
The lessee must use the asset for lawful purposes. Any usage contrary to Islamic principles (such as for
prohibited business activities) would invalidate the Ijara contract.
4. Rental Payments
The rental amount must be specified and agreed upon by both parties in advance. The amount should be
clear, definite, and not subject to change during the lease term.
5. Lease Duration
The lease term must be fixed and known from the beginning. An indefinite lease term is not allowed.
The lessor is responsible for essential maintenance and repairs to keep the asset usable, while the lessee
is responsible for routine maintenance.
1. Definition
Murabaha: A type of sale where the seller discloses the cost of the item and adds an agreed-upon profit
margin for the buyer. It’s often used in Islamic finance to enable asset purchase without charging
interest.
Regular Sale: A general sale transaction where an item is sold for a price agreed upon by both buyer and
seller without disclosure of the initial cost or profit margin.
2. Profit Disclosure
Murabaha: The seller explicitly discloses the original cost of the item and the profit margin added,
ensuring transparency.
Regular Sale: There is no obligation to disclose the cost or profit margin to the buyer. The focus is on the
final sale price.
Murabaha: Commonly used in Islamic finance to structure financing for the purchase of goods or assets.
It allows Islamic banks to finance purchases by buying an asset and then selling it to the customer at a
profit.
Regular Sale: Used in everyday commercial transactions where Islamic financing principles are not
necessarily applied.
1. Riba al-Fadl
Definition: Riba al-Fadl refers to the increase or surplus that occurs in the exchange of similar
commodities or goods of the same type. It arises when there is a trade of commodities in unequal
amounts, leading to an unjust profit.
Characteristics:
Types of Commodities: It specifically applies to goods that are considered homogenous, such as gold,
silver, wheat, or dates.
Prohibition: The Prophet Muhammad (peace be upon him) prohibited the exchange of similar goods
unless they are equal in quantity and exchanged hand-to-hand (immediate delivery).
2. Riba al-Nasiah
Definition: Riba al-Nasiah refers to the interest charged on loans or the extra amount that is paid back
over and above the principal amount in a deferred payment scenario. It is the most commonly
understood form of interest.
Characteristics:
Loans and Debts: It occurs when money is lent with the expectation of receiving back more than what
was originally lent, regardless of whether the loan is for consumption or investment.
Prohibition: Charging or paying interest on loans is strictly prohibited in Islamic finance. Any increase on
the principal amount due to the delay in repayment is considered Riba al-Nasiah.