ISLAMIC BANKING Lecture 2

LEARNING OUTCOME

Student will be able to understand the salient

features of Islamic Banking;
Students will be able to differentiate Islamic
Banking & Conventional Banking;
Students will be able to understand the concept
of Riba, Maysir & Gharar in Islamic Banking
The Islamic bank basically implements a
new banking concept in that it adheres
strictly to the ruling of shari’ah in the fields
of finance and other dealings”.
The foundation of Islamic banking is
based on the Islamic faith.
All the actions and deeds of its
practitioners are bound by the limits of
Islamic law or the shari’ah.
GOALS AND OBJECTIVES OF ISLAMIC BANKING

Offer Financial Services

• The thrust is towards financing on risk- sharing and strict focus on halal
activities
• Focus on offering banking transactions adhering to Shariah principle and
avoiding conventional interest- based banking transactions.

Economic Development

• Established a direct and close relationship between the bank’s return on

investment and the successful operation of the business by the entrepreneur.

Optimum Resources Allocation

• Considered to be most profitable, religiously permissible and are

beneficial to the economy.

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GOALS AND OBJECTIVES OF ISLAMIC BANKING

Optimum Approach

• Profit- sharing principle encourages banks to go for projects with long-

term gains instead of short- term gains.
• Banks conduct proper studies before getting into projects. High returns
distributed to shareholder maximize the social benefits and bring
prosperity to the economy.

Equitable Distribution of Resources

• Ensures equitable distribution of income and resources among the

participation parties, with its profit- sharing approach which is one of a
kind.

Facilitate Stability in Money Value

• Islam recognize money as a means of exchange and not as a commodity.

• Riba- free system leads to stability in the value of money to enable the
medium of exchange.

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 DISTINCTIVE FEATURES OF
ISLAMIC BANKING
The most distinctive features of Islamic banking are
 the prohibition of interest (riba), whether nominal or excessive,
simple or compound, fixed or floating.
the prohibition of gambling (maysir);
dealing only in lawful (halal) things and;
the elimination of uncertainty and ambiguity (gharar) in business
contracts.
 ISLAMIC BANKING – FOUNDATIONS
Any predetermined payment over and above the actual amount of
principal is prohibited. (prohibition of riba - interest).
The lender must share in the profits or losses arising out of the
enterprise for which the money was lent. (profit and loss sharing)
Making money from money is not Islamically acceptable. Money must
work as capital not as debt.
Gharar (uncertainty, risk or speculation) in transactions is prohibited.
Investment should be confined to products and services that are not
forbidden.
RIBA
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 INTRODUCTION
Riba was gradually prohibited through 4 stages in 4 different verses in the
Quran
Practice of giving and taking riba has been widely practice in Arab society
and regarded as part and parcel of the business society
To eliminate something that have been accustomed for so long is not an easy
task
This approach also adopted in the prohibition of liquor
Arab society had been given ample time to gradually adjust themselves

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 RIBA IN THE QURAN

Al-Bay’ as
Stages Of Moral
Legal
the
Riba & the Prohibition of
Prohibition denounciatio
Jews Riba
alternative to
n of Riba Riba
Of Riba In (An-Nisa : 61) (Ali-Imran:
(Al-Rum : 39) (Al-Baqarah:
The Quran 130-132)
275-281)

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 PROHIBITION OF RIBA
STAGES VERSES

1st

2nd

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 PROHIBITION OF RIBA
STAGES VERSES

3rd

4th

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 DEFINITION
Literally:
 Riba is an Arabic word, derived from the verb raba that literally means ‘to grow’ or ‘expand’ or
‘increase’ or ‘inflate’ or ‘excess’
 Excess quantity, addition, an increase of a thing over and above its original size or amount

It is generally translated into English as “usury” or “interest”, but in fact it has a

much broader sense in the Shari`ah.
Riba in the Shari`ah, technically refers to the ‘premium’ that must be paid by
the borrower to the lender along with the principal amount as a condition for
the loan or for an extension in its maturity.
In fiqh terminology, riba means an increase in one of two homogeneous
equivalents being exchanged without this increase being accompanied by a
return.
Technically (2 definition depending on the nature of transaction):
 Trade Transaction
 Loan Transaction
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 PROHIBITION OF RIBA
Definition of Riba on Trade transaction

• Unlawful gain derived from the quantitative

inequality of the counter-values in any transaction
purporting to effect the exchange of 2 or more
species which belong to the same genus(category)
and are governed by the same efficient cause(illah)

Definition of Riba on Loan transaction

• A predetermined excess or surplus over and above

the loan received by the creditor conditionally in
relation to a specified period

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 CATEGORIES OF RIBA
Debt Riba
Riba Qardh
Riba Jahiliyyah
Trade Riba
Riba al-Fadl
Riba al-Nasiah

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 DEBT RIBA
Riba Qardh
 Any predetermined benefit for the owner of debt stated in the contract, which
the debtor need to fulfil
 E.g.: interest stated in loan contract
Riba Jahiliyyah
 The surplus or excess payment above the original debt as a penalty to the
debtor due to his inability to service the loan repayment within the stipulated
time
 Real and primary form of riba
 Premium paid to the lender in return for his waiting
 Giving or taking of every excess amount in exchange of a loan at an agreed
rate irrespective of whether it is low or high
 E.g.: interest in credit card transactions due to the delay in the repayment

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 TRADE RIBA
Riba al-Fadl
Any additional quantity or inequality in the exchange
of goods from the similar type of the ribawi items
(Quantity Factor)
Riba al-Nasiah
Any delay in the exchange of the ribawi items from the
same type and category
(Time Factor)

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 EVIDENCE
Al-Quran
 Al-Baqarah: 275

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 EVIDENCE
Hadith:
 From Jabir: The Prophet saw cursed the receiver and the
payer of usury, the one who records it and the two
witnesses to the transaction and said: “They are all alike
(in guilt and sin).
 From Abi Said al-Khudri: The Prophet saw said: gold for
gold, silver for silver, wheat for wheat, barley for barley,
dates for dates, salt for salt, like for like, and hand to
hand. Whoever pays more or takes more has indulged in
riba. Take taker and the giver are alike (in guilt).

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 RIBAWI ITEMS
Commodity Money/ Currency:
Gold
Silver
Currency
Foodstuff:
Wheat
Barley
Dates
Salt

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 RIBAWI ITEM

(1) Prompt delivery (time)

(2) Prompt delivery with the equivalent quantity

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ISLAMIC RULINGS ON RIBA IN TRADE
Categor Type
y
Exchange Quantity Items

1 Same Same Spot Equal in Regardless of Gold with Gold,

category type exchange quantity quality Wheat with
Wheat

2 Same Different Spot Inequality Equality is not God with Silver

category type exchange is a condition Wheat with Rice
permitted Salt with Dates

3 Differen Different Delayed is Inequality Time and Gold with Wheat

t type permitted is Quantity RM with Dates
category permitted Factor is not a
condition

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 ISLAMIC RULINGS ON RIBA IN TRADE
Category Type Exchange Quantity Items

4 Ribawi Items and Non- Delayed is Inequality is Time and RM with vehicles
Ribawi Items permitted permitted Quantity Factor UD with furniture
is not a
condition

5 Between 2 Non-Ribawi Delayed is Inequality is Time and Bricks with Sands

Items permitted permitted Quantity Factor Cloth with Patrols’
is not a
condition

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REASONS FOR PROHIBITION OF RIBA
An exploitation
To prevent of people
injustice between needs. Thus, they
contracting have no choice
parties but to be
involved in Riba

An exploitations
of people
Exploit the ignorance over
poor/ the types of
creditors commodities
involved in
transaction

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THE RATIONAL BEHIND THE PROHIBITION OF RIBA
Barter system is not so favourable from the Shariah point of view.
The impact of riba is on the society at large compared to other crimes prescribed
in hudud which impact are restricted to only a few of people.
It is a clear burden on the borrower. In any circumstances, he is obliged to repay
the principal and interest charge (Money renting). Money and time cannot grow by
themselves.
Riba is the main pushing factor for the people with surplus of money to lend their
money out to the deficit units in the economy. However, it could render to
exploitation of deficit units by the surplus units.
To prevent any form of injustice, exploitation and manipulation among the parties.
The inflexibility of interest charge results in loss and unemployment in comparison
with the profit-and-loss sharing system.
Security oriented vs Growth oriented. Interest-based system is not for the poor
parties with poor creditworthiness.

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 ..CONT

Inequality in loan distribution makes the rich becomes richer and the poor becomes
poorer.
Interest-based system impends the innovations amongst the small-scale enterprises
particularly.
Wealth creation and transfer: Riba activities do not create a new stock of wealth.
Borrowers are not exposed to any risk (except credit risk - does not commensurate
the profit made).
Money is considered as commodity is an interest-based system and subject to the
law of demand and supply (Allowing speculation on money).
Interest is a component of costs in an interest-based system.
Case Studies:
Bank interest
Riba al-fadl
Similarities between trade and riba

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MAYSIR (GAMBLING)
 PROHIBITION OF MAYSIR
Refers to the easy acquisition of wealth by
chance, whether or not it deprives the other’s
right.
Qimar means the game of chance in which one
gains at the cost of others.
Issues that related to gambling:
Contest using SMS
The prize winning tickets
Horse racing
Lottery
Crossword puzzles
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According to Kamali “The Qu’ranic prohibition of maysir is based on the
premise that an apparent agreement between the two parties is in actuality
the result of unclean and immoral inducement, which is driven by the hope
of making a profit at the expense of the other party to the agreement.”
The gambling parties thus court a risk, which is of their own creation and
which involves both the hope of gain as well as the fear of loss in a way
that is not a necessary part of any of the normal activities in life. (Kamali)
Kamali explains that “If in a contract of sale one party receives what was
due to him, but the other does not and the latter’s side of the bargain is
open to risk-taking (mukhatarah) of a kind that frustrates and nullifies his
right, then the sale partakes both in gharar and gambling at the same time.”
Kamali emphasizes that gambling or qimar is a combative relationship
between two contracting parties, each of whom undertakes the risk of loss
and the loss of one means gain for the other.
Kamali says that it is a violation of the law of equivalence, a kind of
robbery by mutual agreement, like dueling, which is murder by mutual
agreement.
Gambling also consists of an appeal to chance, and making chance the
arbiter of one’s conduct is to subvert the moral order and stability of life.
It focuses attention on material gain and unwarranted reward in a way
that is usually impulsive and can be so overwhelming as to divert attention
from the pursuit of worthier activities in life. (Kamali)
GHARAR (UNCERTAINTY)
 PROHIBITION OF GHARAR
Literally:
Deceit, risk, fraud, uncertainty or hazard that
may be lead to destruction loss.
Technically:
When a matter that is concealed by one party.
Occurs when a party undertake venture blindly
without sufficient knowledge
Minor uncertainties can be permitted when there
is a necessary
Both of contracting parties must have a perfect
knowledge regarding to transaction
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 PROHIBITION OF GHARAR
Examples of Gharar related
transaction:
• Sell good that seller is not in position to
deliver.
• Sell unknown pages or known goods against
unknown price.
• Make a contract conditional on a unknown
event.
• Sell good on basis of false description.
• Sell good without proper examination.
• Gambling.

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 TYPES OF GHARAR

Gharar Yasir Gharar Fahish

• This type of gharar is tolerate and • This type of gharar is not tolerate
will not invalidate a contract. and may result in contract
• Gharar yasir may include the voidability
following cases:
• The uncertainty is slight or trival
• Contract is unilateral or
charitable (al tabarru’at) such
as gift or bequest
• There is a public need for the
transaction or contract
(consideration of maslahah)

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 SIMILARITIES BETWEEN ISLAMIC AND
CONTEMPORARY BANKS

Same purpose: Financial intermediation

Same Objective: Profit
Successcul Operation of Islamic banks has shown that financial intermediation
is possible even without interest.
 DIFFERENCE BETWEEN ISLAMIC AND
CONVENTIONAL BANKING

Islamic Banking Conventional Banking

1) Functions and 1)Functions and operations
operations are based on are based on fully man
Shariah principles made principles
Islamic Banking Conventional Banking
2) No right of profit if there is 2) In contrast, it is almost risk
no risk involved. The profit and free banking and depositor
loss sharing depositor may has no risk of losing its money
lose money in case of loss. because interest is
guaranteed.
Islamic Banking
3) It promotes risk sharing
between provider of capital
(investor) and the user of
funds (entrepreneur).
Conventional Banking
3) In contrast, the investor is
assured of a predetermined
rate of interest.
Islamic Banking Conventional Banking

4) It aims at maximizing 4) In contrast, it also aims

profit but subject to Shariah at maximizing profit
restrictions. without any restriction.
Islamic Banking Conventional Banking
5) Participation in partnership
5) In contrast, ending money
business is the fundamental
and getting it back with
function of the Islamic banks.
compounding interest is the
fundamental function of the
conventional banks.
Islamic Banking
6) The Islamic banks have no provision to
charge any extra money from the
defaulters. Only small amount of
compensation and these proceeds is
given to charity. Rebates are give for
early settlement at the Bank's discretion
Conventional Banking
6) In contrast, conventional
banks can charge additional
money (penalty and
compounded interest) in case
of defaulters.
Islamic Banking
7) the status of Islamic bank in
relation to its clients is that of
partners, investors and trader,
buyer and seller.
Conventional Banking
7) In contrast, the status of a
conventional bank, in relation
to its clients, is that of creditor
and debtors.
Islamic Banking
Conventional Banking
8) one of the service-oriented
functions of the Islamic banks 8) In contrast, the conventional
to be a Zakat Collection Centre bank does not deal with Zakat.
and they also pay out their
Zakat.