Islamic Banking

Instructor: Shahina Batool

Subject: Banking And Public Finance
Semester: 5th
What is Islamic Banking
• There are different banking systems in the world, but the most famous
ones are Islamic and conventional banking.
• The main function of the conventional bank can be summed up in one
sentence: The banks borrow to lend. They borrow in the form of
deposits and lend this money to earn interest.
• In the contrary, the Islamic banking system is based on the principle of
partnership.
• Islamic banking is defined as : “The shareholders, the depositors and
the borrowers-all would participate in an asset or business, on a profit-
loss sharing basis”.
Islamic Banking System
• It is a financial management system that is based on the Islamic rules
of Sharia.
• The main concept is the prohibition on the collection of interest.
• Muslim banking is a saving money framework that depends on the
standards of Islamic law, additionally known as Shariah law, and is
guided by Islamic financial matters.
• Two fundamental standards behind the concept of Islamic banking are
1. The sharing of benefits and misfortune
2. Gathering interest or Riba isn’t allowed under Islamic law.
How does Islamic Banking
• Keeping in mind the end goal to procure cash without charging
premiums, Islamic banks utilize value support frameworks. This
implies if a bank credits cash to a business, the business pays back the
advance without a premium, yet it gives the bank an offer in its
benefits.
• In the event that the business defaults on the advance or do not win
any benefits, the bank does not get any benefit either.
Is Islamic Banking System Really Islamic?
• Yes, only if an Islamic financial institution is running according to the
rules and regulations defined by Shariah. In case any organization is
not following the rules defined in Quran and Hadith they shouldn’t
claim themselves as an Islamic bank.
What is Riba or Interest?
• Riba is an Arabic word. Which means Excess, Increase and addition.
• In Quran it is used for interest.
• Interest is “ A person lends money to another person and asks the
debtor to pay it back together with an agreed additional sum of
money within a fixed period”.
• The Rate of interest is fixed for a specific period. And if the principal
amount along with the interest was not paid within that period the
rate of interest was enhanced for the extended period and so on.
• This enhanced or additional amount is Riba.
Principles of Islamic Banking
• Islam has set values and goals that meet all the economic and social
requirements of human life. Islam is a religion that not only focuses on
the success of the afterlife but also organizes the life of a person
perfectly. The Islamic laws are known as Sharia which means clear
path. The present banking system is based on prohibited financial
elements, which are against the principles of Islamic banking. Here we
discuss the six major principles of Islamic finance and banking
Principles of Islamic Banking
1. Profit and Loss Sharing
2. Shared Risk
3. Prohibition of Riba
4. Prohibition of Gambling
5. No Investment in the prohibited industries
6. Zakat
Profit and Loss Sharing
It is one of the key principles of Islamic finance, where the partners will
share their profit and loss according to the part they played in the
business. There will be no guarantee on the rate of the returns and the
Individual will play the part of a partner and not a creditor.
Shared Risk
• In economic transactions, risk sharing is promoted by Islamic banking.
When two or more parties will share the risk, which is based on the
principles of Islamic banking, the burden of the risk will be divided
and reduced among the parties. So it will improve the economic
activity of the state.
Prohibition of Riba
• It can be regarded as the prohibition of interest:
• The wealth will get a return without any risk or effort.
• Regardless of the outcome of economic activity, the person who gets
the loan has to return the money and Riba to the lender.
• According to the principles of Islamic finance, taking advantage of the
issues that others are facing is unjust.
Prohibition of Gambling
• In Islam, the acquisition of wealth through evil means or participation
in gambling is prohibited. It will protect Muslims from conventional
insurance products because that is a type of gambling. On the other
hand, Islamic banking works in Takaful involve mutual responsibility
and shared risks.
No Investment in the Prohibited Industries
• Industries that are harmful to society or have a threat to social
responsibilities are prohibited in Islam. They include
• Alcohol.
• Pork.
• Drug.
• One is not allowed to invest in such industries, or even participate in
the mutual funds that will help the industry to flourish.
Zakat
Zakat, which allows the balanced distribution of wealth. According to
Islamic principles, an individual who owns a specific amount of wealth
must pay a certain percentage of his/her wealth every year.
The amount of Zakat is deducted from the accounts of Muslims in the
holy month of Ramadan. Islamic banks promote this social
responsibility and distribute the amount among the needy.