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Frequently Asked Questions on Islamic Banking Paper

Words: 1246, Paragraphs: 20, Pages: 5

Paper type: Essay , Subject: Banking

1. THE HOLY QUR’ANHAS PROHIBITED RIBA. WHAT IS MEANT BY THIS TERM?

The term Riba can be loosely translated into the financial concept of ‘interest’. As per Shariah law and Islamic scriptures, the practice of giving or taking interest upon principal is prohibited. In financial transactions a few types of Riba could arise, namely, riba al-qard, riba al-nasa or riba al-Quran. It so happens in Islamic societies that traders and bankers tend to circumvent explicit payment of interest through other subtler means. Taking congnisance of this loophole, Islamic scholars have identified ribas such as riba al-fadl and riba al-buyu, so that the faithful would be forewarned of forbidden commercial practices.

2. WHAT IS THE SCOPE OF TRANSACTIONS TO WHICH THE BAN ON RIBA IS APPLICABLE? DOES THE TERM APPLY ONLY TO THE INTEREST CHARGED ON CONSUMPTION LOANS OR DOES IT ALSO COVER PRODUCTIVE LOANS ADVANCED BY BANKING AND FINANCIAL INSTITUTIONS?

The Shariah clearly states that riba al-nasi’ah, “the fixing in advance a positive return on a loan as a reward for waiting” is prohibited. Hence it could be understood as a ban on interest as commonly used today. Islamic jurists, the fuqaha, state in no unclear terms that all manifestations of riba are forbidden. So it does not matter if the context is consumption or business and also whether the loan in issued or availed. It is also irrelevant whether the institution in question is a commercial bank, government agency, business enterprise or an individual.

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3. DOES THE PROHIBITION OF RIBA APPLY EQUALLY TO THE LOANS OBTAINED FROM OR EXTENDED TO MUSLIMS AS WELL AS NON-MUSLIMS?

The Islamic Fiqh Academy (IFA), which is the leading authority on financial transactions, mentions that there is no leniency in the application of Shariah laws even if one party of a financial transaction is non-Muslim. In other words, if either the issuer or receiver of a payment is non-Muslim, the forbidden forms of ribas discussed above would still remain prohibited. This clarification is made in resolution no. 10/2 of the IFA.

4. THE VALUE OF PAPER CURRENCY DEPRECIATES IN INFLATIONARY SITUATIONS. IN ORDER TO COMPENSATE LENDERS FOR THE EROSION IN THE VALUE OF THEIR PRINCIPAL, A SCHEME OF “INDEXATION” HAS BEEN SUGGESTED. IS SUCH A SCHEME ACCEPTABLE FROM AN ISLAMIC POINT OF VIEW?

In economies with high rates of inflation, restrictions imposed by Shariah laws can undermine value of investments. To compensate for such a loss, a method of indexation is usually employed. There is no consensus yet among the fuqaha, as to the compatibility of indexation practices with Islamic scriptures. So far the Fiqh Academy has permitted indexation in cases pertaining to “wages and contracts fulfilled over a period of time” and has disallowed in cases pertaining to monetary debts. Similarly, “for debts in a specific currency, due in installments, the parties may agree to settle the installments due in a different currency at the prevailing rate of exchange on the date of settlement”.

5. WHAT ARE THE MAJOR MODES OF FINANCING USED BY ISLAMIC BANKS AND FINANCIAL INSTITUTIONS?

Islamic banking system has invented a few ingenious modes of financing in order to comply with Shariah principles. The first mode is based upon sharing of both profits and losses incurred by investments, respectively the mudarahab (passive partnership) and musharakah (active partnership). The second mode operates on the basis of credit offered durig the purchase of goods and services and uses such financial concepts as murabahah (sales contract at a profit markup), ijarah (leasing), salam and istisna (contracts). These modes are unique to Islamic finance and have been approved by fiqh officials. Apart from being consistent with Islamic precepts, these modes incentivise direct investments, thereby contributing to economic growth of the bank/institution/country. Yet, improvements need to be done in order to integrate Islamic financial system into global economy.

6. IN THE ABSENCE OF LENDING AT A RATE OF INTEREST, WHAT MODES OF FINANCING CAN BE USED FOR: A) TRADE AND INDUSTRY FINANCE, B) FINANCING THE BUDGET DEFICIT, C) ACQUIRING FOREIGN LOANS?

Although Islam objects to the concept of interest, it offers several other legitimate instruments of finance, through which commercial activity could be conducted. For financing trade and industry Murabahah (installment sale), leasing and salam are permissible options. Also the concept of istisna could be employed for transactions. Participation in equity markets of companies is made possible; so also is “timed and diminishing musharakah with clients”. Since trade and industry financing is required for purchasing raw materials, goods and fixed assets, these modes of financing come handy. They can also help alleviate working capital requirements (which are predominantly monthly recurrent expenses) for a business organization. Similarly, Islamic scholars have devised legally valid instruments of finance for solving budget deficits. They have also conceived alternative funding arrangements to foreign loans.

7. WHAT IS AN ISLAMIC BANK? HOW DIFFERENT IS IT FROM A CONVENTIONAL BANK?

The first major difference between conventional banking and Islamic banking is that the former is a system of heterogeneous models, whereas the latter is standardized and homogeneous where ever it is implemented. There are also two broad categories of conventional banks – commercial banking and universal banking. Commercial banks face risks such as moral hazard and information asymmetries between the borrower and the lender. It also bears certain inefficiencies in its operations. Universal banking is relatively less risky as well as more efficient. An Islamic bank, on the other hand is a “deposit-taking banking institution” which offers a wide-range of financial services to customers, excepting borrowing and lending for interest. It uses mudarabah or wakalah contracts to mobilize funds; it can also accept demand deposits. The underlying operating principle of Islamic banks is adherence to laws set out in the Shariah.

8. IF BANKING WERE TO BE BASED ON INTEREST-FREE TRANSACTIONS, HOW WOULD IT WORK IN PRACTICE?

Since the services offered by Islamic banks are comparable to those offered by conventional banks, it is interesting to learn how they accomplish this despite limitations imposed by Islamic scriptures. To begin with, Islamic banks are structured as joint stock companies where shareholders are represented in the Board of Directors. The contracts of mudarabah or wakalah are employed during the resource mobilization process. In the absence of interest payments, a profit/loss sharing mechanism is worked out with investors based upon proportionate capital contributions. Investors could choose a generic deposit or a specific investment opportunity. Islamic banks also use interest-free current accounts to manage cash-flow and other investment needs.

9. DO WE REALLY NEED ISLAMIC BANKS?

As with conventional banks, Islamic banks perform the most crucial social function of financial intermediation, whereby they serve to bring together savers, investors and entrepreneurs. Financial intermediation streamlines an economic system and facilitates transfer of funds from lender to borrower, where the latter can utilize these funds for infrastructure development, industry expansion and other projects. By allocating resources on a production basis, Islamic banks provide incentive to development projects as opposed to dubious/risk-prone investment opportunities. Hence, Islamic banks offer a safer and more productive deposit schemes for its customers.

10. IS ISLAMIC BANKING VIABLE?

Organized Islamic banking is relatively new compared to conventional banking systems. As Islamic banking procedures, deposit schemes and other services keeps evolving, they will eventually be able to compete on par with Western banking institutions. Even as it is, Islamic banking is gaining a positive reputation for delivering superior returns. Islamic banking is even adopted in some non-Muslim countries, which serves as a testament to its viability and principles of operation.

Frequently Asked Questions on Islamic Banking

About the author

This sample essay is completed by Harper, a Social Sciences student. She studies at the University of California, Santa Barbara. All the content of this paper is just her opinion on Frequently Asked Questions on Islamic Banking and should not be seen as the way of presenting the arguments.

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Frequently Asked Questions on Islamic Banking. (2019, Feb 19). Retrieved from https://paperap.com/paper-on-frequently-asked-questions-on-islamic-banking/

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