Islamic Banking
&
Finance
Islamic banking is defined as a banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Islamic Shariah but also to avoid unethical and un-social practices.
In a practical sense, Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic Prosperity.
Philosophy of Islamic Banking
The philosophy of Islamic banking takes the lead from Islamic Shariah. According to Islamic Shariah, Islamic banking cannot deal in transactions involving interest/riba (an increase stipulated or sought over the principal of a loan or debt). Further, they cannot deal in the transactions having the element of Gharar or Maiser.
Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of Islam). Islamic banks focus on generating returns through investment tools which are Shariah compliant as well. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of finance.
KEY TAKEAWAYS OF ISLAMIC FINANCE
● Islamic banking, also referred to as Islamic finance or Shariah-compliant finance, refers to finance or banking activities that adhere to Shariah (Islamic law).
● Two fundamental principles of Islamic banking are the sharing of profit and loss and the prohibition of the collection and payment of interest by lenders and investors.
● Islamic banks make a profit through equity participation, which requires a borrower to give the bank a share in their profits rather than paying interest.
Some conventional banks have windows or sections that provide designated Islamic banking
services to their customers.
Understanding Islamic Banking Practices
There are approximately 520 banks and 1,700 mutual funds around the world that comply with Islamic principles. 1 Between 2012 and 2019, Islamic financial assets grew from $1.7 trillion to $2.8 trillion and are projected to grow to nearly $3.7 trillion by 2024, according to a 2020 report by the Islamic Corporation for the Development of Private Sector (ICD) and Refinitiv. 2 This growth is largely due to the rising economies of Muslim countries (especially those that have benefited from oil price increases).
10%
The anticipated growth of the global Islamic finance industry over 2021 to 2022 due to increased bond issuance and a continuing economic recovery in the financial markets, according to S&P Global Ratings. Islamic assets did manage to expand over 10% in 2020, despite the COVID-19 pandemic
Islamic banking is grounded in the tenets of the Islamic faith as they relate to commercial transactions. The principles of Islamic banking are derived from the Quran–the central religious text of Islam. In Islamic banking, all transactions must comply with Shariah, the legal code of Islam (based on the teachings of the Quran). The rules that govern commercial transactions in Islamic banking are referred to as fiqh al-muamalat .
Employees of institutions that abide by Islamic banking are trusted to not deviate from the fundamental principles of the Quran while they are conducting business. When more information or guidance is necessary, Islamic bankers turn to learned scholars or use independent reasoning based on scholarship and customary practices.
One of the primary differences between conventional banking systems and Islamic banking is that Islamic banking prohibits usury and speculation. Shariah strictly prohibits any form of speculation or gambling, which is referred to as maisir.
Shariah also prohibits taking interest on loans. In addition, any investments involving items or substances that are prohibited in the Quran—including alcohol, gambling, and pork—are also prohibited. In this way, Islamic banking can be considered a culturally distinct form of ethical investing. To earn money without the typical practice of charging interest, Islamic banks use equity participation systems.
Equity participation means if a bank loans money to a business, the business will pay back the loan without interest and instead give the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit. In general, Islamic banking institutions tend to be more risk-averse in their investment practices. As a result, they typically avoid business that could be associated with economic bubbles.
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