Islamic banking which is also known as “Sharia compliant finance”, meaning banking activity that is consistent with the principles of Sharia- the moral code and religious law of Islam.
Islamic banking has the same purpose as conventional banking- making money by lending out capital, while following the rules of Shariah. In order to be Islamic, the banking system has to avoid interest and its operations cannot involve elements which are not approved by the religious laws of Islam.
Islamic Banking Principles
The basic principle of Islamic banking is based on risk-sharing. This is viewed as a component of trade as opposed to a risk-transfer which is how conventional banking is regarded. Sharia forbids the fixed or floating payment or acceptance of specific interest rates or fees known as Riba.
Simply put, payment of charges for the renting of money is prohibited under Sharia. Further, there should be an avoidance of;
- Speculation - Gharar
- Avoidance of oppression - Zulm
- Discouragement of the production of goods and services that contradicts the Islamic principles - Haram
Common Shariah concepts used in Islamic Banking
We shall now define a few of the Islamic banking terms that people- associated with it and not-will hopefully now be able to grasp a greater understanding of the topic and type of banking.
- Mudharabah involves the relationship between an investor and the entrepreneur. Profits between the two parties will be shared according to an agreed percentage while losses are all exclusively taken on by the investor.
- Musyarakah is practical for business partnerships where profits are shared on an agreed ratio while losses are divided based on the equity participation ratio.
- Murabahah means that the purchase, selling price as well as profit margin and other costs must be clearly stated at the time and place of the transaction arrangement.
- Wadiah permits the secured looking after of the customers deposits in the bank with a guaranteed reimbursement when the depositor requires it.
- Wakalah is when a person employs someone else to complete transactions on their behalf.
- Hibah is a token that is given voluntarily in return for a loan given or due to some benefit that was obtained.
We hope that this basic guide to Islamic banking will shed some light on this topic. You can read more in-depth articles and guides on Comparehero’s blog!
See also: Your Guide To Islamic Credit Cards