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ABSTRACT
Smooth financial operations are quite impossible without banking and interest is the
pivotal element of conventional banking activities which is strictly prohibited in Islam. So,
to avoid interest as well as to meet banking needs, the Muslim requires such a banking
system that avoids interest and in compliance with the 'Shariah'; commonly known as
Islamic banking. The study shows that the Islamic banking is not only a substitute to
interest-based conventional banking, but also a real alternative to the Muslim. There are so
many differences between the two systems and generally should not be compared with each
other as they are operated under the different set of thoughts; values and rules-regulations.
In spite of that, a large number of people are using Islamic Banking as an alternative to the
interest-based conventional banking. This paper is aimed at discussing and sharing
knowledge on Islamic banking by understanding the concept of Islamic banking; origin of
Islamic banking; principles of Islamic banking; deposit mobilization and fund utilization
mechanisms of Islamic banking; welfare activities of Islamic banking and the regulatory
framework of Islamic banking.
Copyright © 2015, Scholar Journals. All rights reserved.
Keywords: Islamic Banking, Interest-free Banking, Riba-free Banking, Shariah-based
Banking, Halal Banking, Muslim's Banking, PLS Mechanisms.
JEL Classifications: G21, R15
1. INTRODUCTION
Bank and banking have become an integral part of our modern life. The living is not
possible without financial transactions, and smooth or systematic financial activities
require a suitable banking system. Today's economy and civilization are depending on
banks to a great extent. Nowadays banking activities are not limited only with the
mobilization of deposits, using that in a convenient manner and giving back that to
depositors' on demand; but also handling thousand of works in exchange of interests, fees
or commissions. But interest is clearly as well as strictly prohibited in Islamic Shariah, i.e.,
for Shariah restrictions interest related activities are not acceptable to the Muslims (Rufai,
2014). As a result, the Muslim needs a unique banking system based on Islamic values and
principles, commonly known as 'Islamic Banking'(Rahman & Rahman, 2007). Islamic
banking has made it possible to keep the people away from the interest as well as to
address all the banking needs simultaneously and has become an ideal alternative to the
interest-based conventional banking worldwide.
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International Scholar Journal of Accounting and Finance, 1(1), 2015, 33-40
Following Shariah regulations: Islamic banks operate its activities in accordance with
the Shariah rules, known as Fiqh-al Muamalat (Islamic rules on transactions).
The consensus of Islamic banking to that of conventional banking is only to the extent
that banks are financial intermediaries mobilizing savings and channelizing the resources
towards productive investments (Nihar & Subramanyam, 2011).
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International Scholar Journal of Accounting and Finance, 1(1), 2015, 33-40
7.3 Bai-Mechanism
Bai-Muajjal or deferred or credit sales: Under Bai-Mechanism, Islamic bank contracts
with its client to sell specified goods, as per client order, at an agreed price payable in
lump sum or in installment within a fixed period of time. In this mode, ownership of the
goods is transferred to the client with the delivery of the goods, but the payment of that is
deferred by the client for a specified period. In a Bai-Muajjal contract, it is permitted to
charge a higher price than the prevailing market price. And the bank, however, is not
required to disclose the cost of the goods and the profit markup separately.
Bai-Murabaha: Bai-Murabaha is a sale agreement where Islamic bank sales a Shariah
permissible goods to a bank's client at cost, plus an agreed profit. The profit margin may
be a percentage of the cost or a lump sum and the buyer may pay the price in cash or
within a fixed period as a lump sum or in installments. In a Bai-Murabaha agreement
cost of the goods and the amount of the profit therewith have to be mentioned separately
and clearly. And the price once fixed can't be increased for the cause of unexpected
deferred payment, i.e. the amount of profit has, under any circumstances, no relationship
with the time period.
Bai-Salam: Bai-Salam is a contract between a buyer and a seller where a seller sales a
Shariah compliant commodity in advance at an agreed price which is fully payable on
execution of the said contract, though the commodity will be supplied at a certain future
time and at a particular place, as per specification like size; color; quantity; etc. By
following this, an Islamic bank can pre-purchase the future output of a firm at an agreed
price, specifying the product details along with the delivery time and place. Sometimes
Islamic bank pays on behalf of an importer or wholesaler, for such a forward purchase,
who agrees to repay the bank after reselling the goods.
Bai-Istisna: Bai-Istisna is a sale contract between a seller and a buyer where the seller
undertakes an order to have manufactured or acquired something for the buyer as
specified and sales it at an agreed price. The buyer may pay the price in advance or, on
the basis of an agreement, it can be deferred. However, the payment can also be paid as a
lump sum or in installments over a specified period. In the absence of any restriction by
the buyer, a seller can use a third party to get the work done or the product ready.
Bai-Istijrar (Supply Sale): Bai-Istijrar is such a contract where the supplier of a product
supplies to its clients on a regular basis and at an agreed price or mode of payment.
Bai-Inah: Bai-Inah is an agreement where an asset is sold at an agreed price and
brought back again at a higher price, normally, than the previous sale price. In a Bai-
inah agreement, both the sell and buy contracts will be independent and separate; and
one must not be made as a condition of another.
Bai-Musawama: Bai-Musawama is a sale contract where commodities are bought and
sold for a lump sum price without any reference to the cost.
Juala: Juala is an agreement for buying and selling services in exchange of some
commission or fees.
8. NON-INVESTMENT AND WELFARE SERVICES OF ISLAMIC BANKS
Account opening and maintenance: Account opening is the first step of establishing a
relationship between a bank and a client. A variety of banking activities take place with
the help of this bank account viz., receiving deposit; payment of checks drawn on the
account; execution of bank transfers and orders and so on. Some of these services
rendered by the Islamic banks are for commission or fees, whereas some of those are
absolutely free of cost.
Safe custody: Islamic Banks, like conventional banks, also offer safe custody services to
its clients. The main purpose of this type of service is to serve the clients more. Islamic
banks take a comparatively small charge against rendering this service.
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Money Transfer: Islamic Banks render this service by transferring money in behalf of its
client to another person's account or to another place, as per the instructions, through
Mail Transfer (MT); Demand Draft (DD); Telephonic Transfer (TT); Pay Order (PO) or any
other services like these.
Settlement of transactions: Islamic Bank pays cash against bill-of-exchange; check or
so on of their clients to settle transactions with the other parties.
Opening of L/C: Islamic bank issues letter-of-credit (L/C) on behalf of its clients for the
purpose of domestic and international trade and business.
Providing bank guarantee: A bank guarantee is a written agreement that guarantees
the payment of a debt by the bank, on behalf of its clients, to a third party. If the
customer or importer, under this agreement, fails to pay his debt the bank is responsible
for paying the debt.
Collection of negotiable instruments: To serve its clients an Islamic bank takes
possession of negotiable instruments of its customer and hold them till maturity and
collect the amount from the debtor on behalf of the bank's clients.
Providing Qard-al-Hasana: Quard-al-Hasana is a benevolent or virtuous loan given by
the bank to its special types of clients without any interest, profit or any other collateral
on the principal amount. It is one of the special non-income generating activities by the
Islamic banks.
Mobilizing and distributing of Zakah: Zakah is a 'Farj' (obligatory) obligation for the
rich Muslims by the Shariah. The rich Muslims, as per Shariah rules, donate a specific
quantity of their asset, known as Zakah, to the poor. An Islamic bank accumulates Zakah
to its Zakah fund and distributes, later on, among the poor as per Shariah rules.
There are some other services like factoring, school banking, issuing of travelers checks,
issuing a solvency certificate, etc. are provided by the Islamic banks as well.
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International Scholar Journal of Accounting and Finance, 1(1), 2015, 33-40
10. CONCLUSION
Though interest has an endless negative impact on society -like financial injustice;
improper appropriation of property; negative financial growth and so on, it is still the key
factor acting as the foundation of the conventional banking system. Interest-free Islamic
banking, on the contrary, is as complete as a client expects and has the positive impacts
only. Moreover, it offers the Muslim a great opportunity to abide by the principles of
Shariah. In a real sense, Islamic banking is much better compared to the conventional
banking as it performs well and addresses all the banking needs of its clients.
Additionally, It has an exclusive beauty and fragrance as it is based on a universally
acknowledged principles of equity, honesty, fairness, piousness, as well as on PLS
mechanism and free from all Haraam activities or unwelcome elements like speculation
or Gharar. So Islamic banking is considered as a blessing for all, irrespective of religion,
as it ensures and brings welfare and peace for the society.
NOTES
Conventional Banking: General banking system where interest is the pivotal element
and very much common in our society.
Shariah: Islamic rules and regulation for the Muslim, supported by the Holy 'Quran' and
'Hadith'.
Riba: Unjustified increment on the lending money, irrespective as a condition of the
lender or voluntarily by the borrower. The term 'interest' and 'Usury' are commonly used
instead of the term 'Riba'.
Halal: Complied with the Islamic Shariah. It simply means that something is lawful or
permitted for the Muslim.
Haraam: Activities which are sinful, unlawful and prohibited by the Shariah.
Farj: Activities, for the Muslim, which are obligatory by the Shariah.
Sahaba: Muslim companions as well as followers of the last prophet Muhammad (S.A.W).
Gharar: Absolute or excessive uncertainty of a contract.
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International Scholar Journal of Accounting and Finance, 1(1), 2015, 33-40
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