What is Islamic Banking

INTRODUCTION
This booklet aims to provide you some basic concepts and principles on Islamic
banking.

Islamic banking
Islamic banking is a banking activity which is consistent with the Islamic law
(Shariah). Islamic banking is carried out in accordance with the rules of Shariah,
known as fiqh muamalat (Islamic rules on transactions). It does not allow the
paying and receiving of riba’ (interest) and promotes greater degree of fairness
and equity in the conduct of banking business

The first Islamic bank was established in Malaysia in 1983. In 1993, commercial
banks, merchant banks and finance companies were allowed to offer Islamic
banking products and services under the Islamic Banking Scheme (IBS banks).
The IBS banks are required to ensure that the funds and activities of the Islamic
banking transactions are separated from the conventional banking business.

All licensed Islamic banks and IBS banks are required to display the Islamic
banking logo as shown below:

SHARIAH PRINCIPLES IN ISLAMIC BANKING

The rules and norms of fiqh muamalat emanated from two primary sources of
Shariah namely the Quran and the Sunnah and other secondary and
authoritative sources of Islamic law.
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Islamic banking operates under a number of contracts under fiqh muamalat.

Amongst the widely used concepts in Islamic banking include profit sharing
(Mudharabah), safekeeping (Wadiah), joint venture (Musyarakah), cost plus
(Murabahah) and leasing (Ijarah).

SHARIAH COMMITTEE
The Islamic banks and IBS banks must ensure that their operations comply with
the principles of Shariah. Each institution is therefore required to set up a Shariah
Committee to provide advice on Shariah issues and to ensure that its operations
and activities comply with the Shariah principles. In addition, the Shariah
Advisory Council set up at Bank Negara Malaysia (BNM) is the highest Shariah
authority set up to provide advice on the Shariah matters pertaining to Islamic
banking and takaful in Malaysia.

SHARIAH CONCEPTS IN ISLAMIC BANKING

Wadiah (Safekeeping)
For deposit product or Wadiah contract, a bank is the custodian and trustee of
funds. A person deposits funds in the bank and the bank guarantees refund of
any part or the whole amount of the deposit when requested by the depositor.
The depositor, at the bank's discretion, may be given 'hibah' (gift) as a form of
appreciation for the use of funds by the bank. As a trustee of the items, the
custodian may charge a fee to the customer.

Mudharabah (Profit Sharing)

Mudharabah is a profit sharing arrangement or agreement between a capital
provider and an entrepreneur. The entrepreneur is provided with funds by the
capital provider to undertake a business activity. Any profits made will be shared
between the capital provider and the entrepreneur according to the pre-
determined profit-sharing ratio. However, losses shall be borne by the capital
provider.
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Musyarakah (Joint Venture)

This concept is normally applied for business partnerships or joint ventures. The
profits made are shared on an agreed ratio while losses incurred, will be divided
based on the equity participation ratio.

Murabahah (Cost Plus)

The selling of goods at a price, which includes a profit margin agreed by both
parties. The purchase and selling price, other costs and the profit margin must be
clearly stated at the time of the sale agreement.

Bai' Bithaman Ajil (Deferred Payment Sale)

The selling of goods on a deferred payment basis at a price, which includes a
profit margin agreed by both parties.

Wakalah (Agency)
This is the situation when a person appoints a representative or delegates a duty
to another party to undertake transactions on his behalf. As an agent, the bank
will be paid a fee for the services it provided.

Qard (Interest-free Loan)

A loan extended on a goodwill basis and the borrower is only required to repay
the amount borrowed. However, the borrower may, at his discretion, pay extra
(without promising it) as a token of appreciation.

Ijarah Thumma Bai' (Hire Purchase)

There are two contracts involved in this concept: Ijarah contract (leasing/renting)
and Bai' contract (purchase). The contracts are undertaken one after the other.
For example, in a car financing facility, a customer enters into the Ijarah contract
to lease the car from the owner (financier) at an agreed rental for a specific
period. When the leasing period ends, the Bai’ contract comes into effect, to
enable the customer to purchase the car from the owner at an agreed price.
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Hibah (Gift)
A token given voluntarily in return for loan given or benefit obtained.

Frequently Asked Questions

Q: What is Islamic banking?
A: This is a banking activity based on Islamic principles, which do not allow
the paying and receiving of interest (riba’) and promotes profit sharing in
the conduct of banking business.

Q: Is Islamic banking meant for Muslims only?

A: No. Islamic banking is for all individuals regardless of their religious belief.

Q: What are the differences between Islamic and conventional banking?

A: The most important difference between Islamic and conventional banking
is the prohibition of interest in Islamic banking. Islamic banking activity
must comply with Shariah principles and avoid prohibited activities such
as gharar (excessive uncertainty). For example, instead of lending with
interest, Islamic banks provide financing based on Bai’ Bithaman Ajil
whereby it is based on trade.

Q: How do Islamic banks and IBS reward their depositors since payment of
interest is not allowed?
A: Shariah allows the profit sharing arrangement between the bank and the
depositor. Profits from Islamic banking activities will be shared between
the bank and the depositor based on an agreed profit sharing ratio and
paid in the form of dividends. The amount of dividend payout depends on
the profits generated from the bank’s operation. Shariah also allows the
bank to give hibah to its depositors based on its discretion.

Q: Where can I obtain Islamic banking products and services?

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A: You can obtain Islamic banking products and services at any bank that
carry the Islamic banking logo shown below:

For the latest update on the list of banks that offers Islamic banking
products and services, please visit www.bnm.gov.my

Q: Does the operations of the IBS banks fully comply with the requirements
of Shariah?
A: All Islamic banks and IBS banks are required to set up Shariah
Committees to advise them and to ensure that the operations and
activities of the bank comply with Shariah principles. All products and
services offered by the Islamic banks and IBS banks must be approved by
their respective Shariah Committees.

Q: Can an IBS bank transfer credit balances of a customer's Islamic account

to a conventional account, or vice versa?
A: Upon a customer's request, an IBS bank may transfer funds from an
Islamic account to a conventional account. On the other hand, only the
principal amount can be transferred from a conventional account to an
Islamic account. No element of interest is allowed to be transferred.

Q: What are the avenues available if I am dissatisfied with the services

provided by Islamic banks or IBS banks?
A: You should contact your bank if you have any complaints. All banks have
set up a dedicated Complaint Unit to deal with customers’ complaints.
Information on the contact person, telephone number and e-mail address
is available on Bank Negara Malaysia’s website at www.bnm.gov.my.
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For more information on how to make a complaint, please read the booklet
on “Making a Banking Complaint”.
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Glossary

Gharar
An unknown fact or condition. An element which must be avoided in Islamic
banking transactions since excessive gharar may render the contract null and
void.

Ibra’
Giving up of a right. In an Islamic banking transaction, a creditor gives up part or
all of his right to a debtor usually for early settlement of the debt.

Rahnu
Making an asset as a security for a debt or a right of claim.

Riba'
The excess paid or received over and above the principal in a loan contract.

Shariah
The Islamic law which is derived from various sources – the Quran, the Hadith,
the Sunnah, ijma’ (consensus of Muslim scholars), qiyas (analogy) and ijtihad
(personal reasoning) of the Muslim jurists. It covers every aspect of life.

Zakat
The obligatory payment of a certain proportion of the wealth and each and every
kind of property liable for zakat. This is paid annually for the benefit of eligible
Muslims in the community. It is a major economic means for establishing social
equity and leading the Muslim society to prosperity.