The Nature Definition And Evolution Of Islamic Banking Law Finance Essay


To understand the construct and operations of Islamic banking, it is worthwhile giving an overview of the fiscal establishments. This will assist in understanding how fiscal establishments and merchandises affect persons, houses, societies, economic systems, provinces and how they perform to carry through the demands of assorted sections in an economic system.

Let us analyze what is banking or a bank? The word “ bank ” is said to hold been derived from the Italian word “ banco ” , intending shelf or bench. A bank is an establishment authorized to take sedimentations for the intent of widening long and short-run finance installations. Banking originated in Ancient Mesopotamia where the royal castles and temples provided unafraid topographic points for the guardianship of grain and other trade goods. The modern banking systems maps as fiscal mediators between rescuers and the ultimate users, the families and houses. Besides this, they offer a figure of other services such as safe sedimentations, check installations, easy transportations, overdrafts warrants and bureau maps in regard of purchase and sale, payment and reception, direction and publicity etc. Historically, Bankss have performed this map oA­n the footing of fixed involvement payment. So involvement forms the footing of the bank ‘s traffics with the rescuers every bit good as with the enterprisers to whom it advances money capital, mobilised from depositors every bit good as createdA ad hoc.

Why Islamic banking?

Attention has been focused on Islamic banking and finance as an alternate theoretical account. It is believed that involvement or vigorish is one beginning of development, particularly, as in the instance of sub-prime loaning, the highest rates were charged to lower earners. Such prejudiced charging by conventional banking led to ideas of an alternate banking system. It is a fact that the involvement system is inherently incapable of apportioning available liquid financess among houses and activities in the society harmonizing to considerations of efficiency, productiveness and growing. Thus an Islamic system based on profit/loss sharing funding methods is an efficient replacement in rule. It is besides believed that the involvement system brings approximately and efficaciously maintains a form of income distribution that is biased towards affluent people and big concerns, irrespective of rational economic considerations. The relevancy of Islamic banking, which is marked by kindness and fondness, increases when the Bankss move frontward from development and pitilessness. More over it is believed that Islamic economic system should take to freedom from economic bondage.

Beginning of Islamic Banking: –

Harmonizing to Lieber “ Among Muslims, international trade was peculiarly stimulated by the pilgrim’s journey to the holy topographic points of Arabia, in which a great organic structure of work forces converged each twelvemonth from all over the universe. Many of these pilgrims fulfilled their spiritual duties and at the same clip, marketed their local merchandises along the path, returning place with foreign goods on which they hoped to do a fine-looking net income ” . With the development of trade operations such as loaning, adoption, reassigning, vouching and safeguarding comes the development of banking operations.

The roots to the development of Islamic banking can be traced back to the clip of the Prophet of Islam who introduced the systemA ofA Bayt al-Mal ( State Bank of Muslims ) A for the aggregation and expense of grosss. TheA Bayt al-Mal, A the province bank of the Muslims, was a specialA section of the Central Secretariat supervised and directed by aA particular authorities officer calledA Khazin al-MalA orA Sahib al-MakhazinA and provincial treasurerA KhazinA oraminA and considered among the elitesA of the Muslims. TheA Bayt al-MalA was non onlyA A A the propertyA A A of the Muslims aloneA but of non-Muslims besides, Out of the financess of theA Bayt al-MalA theA State was obliged to back up needyA non MuslimsA every bit good as indigentA Muslims. The public exchequer ofA Bayt al-MalA played the function of an agriculturalA recognition bank and besides a commercial bank from the early yearss of the Umayyads. During the period of 844-848 A.D. , it lent to the provincials two million dirhams.

From the historical Hagiographas of some bookmans we can understand that there were bankers in mediaeval Islamic universe called sarraffeen or sayarifah or jahabidhah and Bankss called dawawin al-jahabidhah. In 913 AD, the province established what is called diwan al-jahabidhah with subdivisions in the chief trade metropoliss carry oning about all modern banking maps albeit without resort to involvement. After thirteenth century due to the internal and external factors a figure of the Islamic establishments, including the Islamic system of fiscal intermediation became displaced by Western establishments.

Development of Modern Islamic Banking: –

From the center of the 19th century, about every Muslim state, under direct or indirect force per unit area from the freshly dominant west, adopted Torahs and legal systems based on Western theoretical accounts, peculiarly in the civil and commercial domains. After freedom from colonisation and the revival of Islam, the demand in Muslim states to follow their economic system based on Islam increased. The pattern of Islamic banking did non get down at the national degree ; alternatively single Islamic Bankss were established in many states during the 1970ss. These Muslim Bankss had to run with the economic and legal restraints of the state. They besides had to confront competition from interest-based Bankss, which were already established in the system.

The first modern experiment with Islamic banking was undertaken in Egypt under screen, without projecting an Islamic image, for fright of being seen as a manifestation of Islamic fundamentalism which was bete noire to the political government. The pioneering attempt, led by Ahmad El Najjar, took the signifier of a nest eggs bank based on profit-sharing in the Egyptian town of Mit Ghamr in l963. This experiment lasted until l967. Mit Ghamr was a start, the first interest-free establishment with ‘bank ‘ in its name, was, Nasser Social Bank, established in Egypt in 1971. This thought attracted the attending of business communities who had surplus financess. Then four old ages subsequently, in 1975, Dubai Islamic Bank was established in Dubai, UAE. It was a private enterprise ; but the authoritiess of UAE every bit good as Kuwait inserted their portion numbering 30 % . It is acknowledged to be the first fully fledged Islamic Bank. However, the most of import development in Islamic Banking is the puting up of the IDB ( Islamic Development Bank ) in 1975.

With the development of several Islamic Bankss, the thought attracted the attending of states such as Iran, Pakistan as Sudan which showed their willingness for execution. IMF and World Bank recognised Islamic banking merchandises as the echt tools of fiscal intermediation. Islamic banking has grown by about 15 per centum a twelvemonth since its modern origin in the 1970s, fueled by the Middle East oil roar of that decennary. Today there are more than 500 Islamic fiscal services establishments worldwide. The entire volume of Islamic assets is believed to be about US $ 500 billion.

Definition and characteristics of Islamic Banking: –

We have already discussed about the beginning and development of Islamic Banking. Let us analyze the nature and characteristics of Muslim Banks.

Definition of Islamic banking: –

An Islamic bank is an intermediary and legal guardian of other people ‘s money like any conventional bank with the possible difference that the final payment to all its depositors is a portion in net income and loss in one signifier or the other. This difference introduces an component of mutualness in Islamic banking, doing its depositors as clients with some ownership rights inherent within it. However, in pattern, Islamic Bankss barely look different from its conventional opposite number in footings of organizational set-up. An Islamic Bank Has been defined in the undermentioned ways ; harmonizing to General Secretariat of the OIC ‘s “ An Islamic bank is a fiscal establishment whose position, regulations and processs expressly province its committedness to the rule of Islamic Sharih and to the forbiddance of the reception and payment of involvement on any of its operations ” . It is basically a normative construct and could be defined as behavior of banking in consonant rhyme with the ethos of the value system of Islam.A

The Islamic Banking system is based on the construct of sharing net incomes every bit good as loss. The general rule is that those who want to gain a return on their nest eggs should besides be willing to presume a risk.. From the above definition it appears that Islamic banking is a system of fiscal intermediation that avoids reception and payment of involvement in its minutess and conducts its operations in a manner that it helps accomplish the aims of an Islamic economic system. Alternatively, this is a banking system whose operation is based on Islamic rules of minutess of which net income and loss sharing ( PLS ) is a major characteristic, guaranting justness and equity in the economic system. That is why Muslim Bankss are frequently known as PLS-banks.

Basic characteristics of Islamic Banking: –

There are rigorous regulations using to finance under Islamic jurisprudence. The economic philosophy of Islam is based on encouraging free markets, detering monetary value controls and prohibiting fiscal contracts based on riba, gharar and maysir Let us analyze the distinguishing characteristics of Islamic banking.

Freedom from Riba: –

Riba is an Arabic word that means “ growing ” or “ addition ” and denotes the payment or reception of involvement for the usage of money. The impermissibility of “ riba ” ( involvement ) at Islamic Shari’a on monies Lent is ordained by the Quran, Sunna, i.e. the prophetic tradition and unanimity of the multitudes of ancient legal experts. The Quran expressly forbids riba, which includes any payment of involvement ( non merely inordinate involvement ) on pecuniary loans. Muslim bookmans have interpreted riba as any fixed or guaranteed involvement payment on hard currency progresss or on sedimentations. One erudite comrade of Prophet Mohammed ( peace be upon him ) was reported to hold said “ He who lends should non qualify more than what he has Lent, even a smattering of fresh fish ; for it is riba. ”

The cosmopolitan nature of these rules is instantly evident even at a casual glimpse of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other authors, peculiarly those composing in the nineteenth century, have attacked the atrocity of the pattern. Even though there are no specific poetries in the Quran or messages from the Sunna providing grounds for the ban of Riba, some surveies argue that Riba contradicts the rules of profit/loss sharing which aims to make a proper balance between the loaner and the borrower. The undermentioned grounds given by Siddiqi are notable ; First, Riba is a signifier of societal corruptness referred to by Arabic bookmans as Fasad. Second, Riba implies the unlawful appropriation of other people ‘s belongings without justification. Third, Riba decreases the resources of provinces through negative consequence on the growing of economic systems. Fourth, Riba demeans and diminishes the humanity of persons. Fifth, Riba leads to money being made from money: an unacceptable pattern in Islamic finance.

Prohibition of Gharar: –

Literally Gharar means Risk or Hazard. The term Gharar has been defined by many bookmans but the followers is notable “ Gharar as the sale of likely points whose being or features are non certain, due to the hazardous nature which makes the trade similar to chancing ” . Al-Dareer defines Gharar in jurisprudential footings under the undermentioned three headers: First, Gharar applies entirely to instances of uncertainty or uncertainness, as in the instance of non cognizing whether something will take topographic point or non. The definition by Ibn Abidin is a instance in point: Gharar is uncertainness over the being of the capable affair of sale.

A 2nd position holds that Gharar applies merely to the unknown, to the exclusion of the doubtful. Therefore, harmonizing to Ibn Hazm, Gharar in gross revenues occurs when the buyer does non cognize what he has bought and the marketer does non cognize what he has sold. The 3rd position is a combination of the two classs above ; Gharar here covers both of the unknown and the doubtful, as exemplified by the definition proposed by Al-Sarakhsy who states that Gharar obtains where effects are concealed. This is the position favoured by most bookmans. However Moslem Jurists disagree on the grade of uncertainness in a dealing to be considered Gharar dealing. It is noted that there is no expressed statement known in the Quran ban Gharar, it is well-accepted that it is out. But amour propre ( albatil ) is out in many poetries. The Holy Quran says that ;

“ And do non eat up your belongings among yourselves for amour propres, nor use it as come-on for the Judgess ” . “ O ye who believe! Eat non up your belongings among yourselves in amour propres ; but allow these be amongst you traffic and trade by common good will ” .

There is a consensus among translators of these poetries that Gharar is amour propre. Ibn Al-Arabi explains that amour propre ( al-batil ) is improper because it is prohibited by Sharia such as vigorish and Gharar. It has reported through a figure of the Prophet ‘s comrades that the Prophet ( PBUH ) has forbidden Gharar in trading.

The principle behind the prohibition of Gharar is to guarantee full consent and satisfaction of the parties in a contract. Full consent can merely be achieved in full revelation and transparence and through perfect cognition from undertaking parties of the counter values intended to be exchanged. The prohibition of Gharar protects against unexpected losingss and the possible dissensions sing qualities or rawness of information.

Free from Maysir: –

The term maysir is defined as gaming, stakes and bet. Islamic bookmans have stated that maysir ( chancing ) and gharar are inter-related. Where there are elements of gharar, elements of maysir is normally present. The kernel of gaming is taking a hazard intentionally created or invited, which is non necessary in economic activity, to derive thereby. Maysir refers to the easy acquisition of wealth by opportunity, whether or non it deprives the other ‘s right. The Holy Quran clearly says that “ They ask you ( O Muhammad ) refering alcoholic drink and gaming. Say: “ In them is a great wickedness and ( some ) benefit for work forces, but the wickedness of them is greater than their benefit. ”

The principle behind the prohibition of maysir in Islam is to advance a well- developed and healthy society that regards difficult work and existent parts in footings of quality, creativeness, and service instead than back up support from gambling-like activities.

Prohibition of utilizing or covering in out trade goods: –

Islamic Finance encourages people to put money but it should follow with the regulations set by Sharia. Harmonizing to Islamic philosophies some trade goods are purely out. So, Islamic fiscal Institutions can non prosecute in funding anti- societal activities such as intoxicant, porc and armaments that are illegal ( Haram ) to an disciple to faith. The principle behind this is to advance ‘ethical ‘ investings that once more do non impact people and society adversely through the misdemeanor of spiritual prohibitions.

Hazard and Net income Sharing: –

One of the cardinal principles of Islamic finance is that under conventional systems based on involvement, the catching parties portion neither net income and loss nor hazard. Islamic banking promotes risk-sharing between the supplier of financess ( investor ) and the user of financess ( enterpriser ) . Net income Loss Sharing ( PLS ) dominates the theoretical literature on Islamic finance. Broadly, PLS is a contractual agreement between two or more transacting parties, which allows them to pool their resources to put in a undertaking to portion in net income and loss. Most Muslim economic experts contend that PLS based on two major manners of funding, viz. Mudaraba and Musharaka, is desirable in an Islamic context wherein reward-sharing is related to risk-sharing between transacting parties. ”

The principle behind this rule is, since the nature of this universe is unsure, the consequences of any undertaking are non known with any certainty ex ante, and so there is ever some hazard involved. In conventional banking, all this hazard is borne by the enterpriser. Whether the undertaking succeeds and produces a net income or fails and produces a loss, the proprietor of capital gets off with a preset return. In Islam, this sort of unfair distribution is non allowed. In Islamic banking both the investor and enterpriser portion the consequences of the undertaking in an just manner. In the instance of net income, both portion this in pre-agreed proportions. In the instance of loss, all fiscal loss is borne by the capitalist and the enterpriser loses his labor.

Difference between conventional banking and Islamic banking: –

Under this heading allow us analyze the difference between Islamic and conventional banking systems.

Major difference between Islamic and Conventional Banking system

Conventional system

Islamic System

Functions and runing manners are based on secular rules, non spiritual Torahs or guidelines.

Functions and runing manners are based on

Shari’a, and Islamic Bankss must guarantee that

all concern activities are in conformity with

Shari’a demands.

Time value is the footing for bear downing involvement on capital.

Net income on exchange of goods and services are the footing for gaining net income.

Money is a merchandise besides medium of exchange and shop of value.

Real Asset is a merchandise. Money is merely a medium of exchange.

While pay outing hard currency finance, running finance or working capital finance, no understanding for exchange of goods and services is made.

The executing of understandings for the exchange of goods and services is a must,

while pay outing financess under Murabaha,

Salamand Istisnacontracts.

Because of non-existence of goods and services behind the money while pay outing financess, the enlargement of money takes topographic point, which creates rising prices.

Because of being of goods and services no enlargement of money takes topographic point and therefore no rising prices is created.

Even if the organisation suffers losingss involvement will be charged. There is no construct of sharing loss.

When the administration suffers loss the loss will be shared.

Bridge funding and long-run loans imparting are non made on the footing of being of capital goods. Rather, they are disbursed on the footing of Windo Dressed undertaking feasibleness and credibleness of the enterpriser.

Musharakah & A ; Diminishing Musharakah

understandings are made after doing certain the being of capital good before pay outing financess for a capital undertaking

Hazard sharing is non by and large offered but is available through venture capital houses and investing Bankss, which may besides take part in direction.

Muslim Bankss offer equity funding with hazard sharing for a undertaking or venture. Losingss are shared on the footing of the equity engagement, whereas net income is shared on the footing of a pre-agreed ratio.

Hazard sharing is non by and large offered but is available through venture capital houses and investing Bankss, which may besides take part in direction.

Muslim Bankss offer equity funding with hazard sharing for a undertaking or venture. Losingss are shared on the footing of the equity engagement, whereas net income is shared on the footing of a pre-agreed ratio.

Real growing of wealth does non take topographic point, as the money remains in few custodies.

Real growing in the wealth of the people of the society takes topographic point, due to multiplier consequence and existent wealth goes into the ownership of batch of custodies.

Because of failure of the undertakings the loan is written off as it becomes non executing loan.

Because of failure of the undertaking, the direction of the organisation can be taken over to manus over to a better direction.

Conventional Bankss may finance any lawful merchandise or service.

Muslim Bankss are allowed to take part merely

in those economic activities that are Shari’a compliant. For illustration, Bankss can non finance a concern that involves selling porc or intoxicant.

Conventional Bankss usually charge extra money ( compound involvement ) in instance of late payments or defaults.

Muslim Bankss are non allowed to bear down punishments for their enrichment. They may, nevertheless, allow infliction of default or late payment punishments on the evidences that these punishments discourage late payments or defaults, which impose administrative costs on Bankss for processing and roll uping the sum owed. Punishments may be donated to a charity or used to countervail aggregation costs.

The position of a conventional bank in relation to its clients is one of creditor and debitor.

The position of an Islamic bank in relation to its clients is that of spouse and investor.

Conventional Bankss do n’t hold any spiritual supervisory boards.

Each Islamic bank must hold a supervisory board to guarantee that all its concern activities are in line with Shari’a demands.

A conventional bank must be in conformity with the statutory demands of the cardinal bank of the state in which it operates and in some topographic points, the banking Torahs of province or other vicinities.

An Islamic bank must be in conformity with the statutory demands of the cardinal bank of the state in which it operates and besides with Shari’a guidelines.

Decision: –

To reason, Islamic banking is considered as an option to conventional banking system.

Although the construct and operations of Islamic banking system started from 6th century AD the modern banking system came into being merely 30 old ages back. There are some cardinal rules, which should be followed, in all traffics. It has many difference with its counterpart conventional system.