Illustrate the Fundamentals of Islamic Banking Essay

Introduction: This report seeks to give an analysis of Islamic Banking and an organisational comparison to a corporate Global banking system/western one whilst identifying key issues and challenges that may arise for the use of such Islamic banking in the United Kingdom. â€Å"Islamic banking is a growing sector with its diversity in different segments and spectrum. It Caters to religious Muslims in Muslim’s societies as well as in countries where Muslims are in a minority. In addition, it is a broad standard: non-Muslim individuals and communities that seek ethical financial solutions have also been attracted to Islamic banking. It is clear from banking practice that Islamic banking is equally popular in all communities†. (www.islamic-bank.com). The first Islamic bank was set up in the late 1960’s in Egypt to fulfil the needs of Muslims who wanted to bank but still live by Sharia law. An Islamic bank is not a religious institution but caters for the needs of the Muslim and is also appealing to non-Muslims who perceive Islamic banking as an alternative to commercial banking successful Islamic banks such as the Dubai Islamic Bank also known as (DIB) who opened in 1975 have set out a good public image for such choice of banking. Over recent years especially in the last decade Islamic banking has seen a rise in popularity and global development in western countries. Upon focusing on the UK The Islamic bank of Britain is United Kingdom’s mainly recognised sh’aria compliant organisation, Usmani, (2005) defines sha’ria compliance as ‘An act or activity that complies with the requirements of sha’riah Islamic law’. Islamic banking As already stated Islamic banking is based on Islamic Sha’riah Law which sets out the principles of all banking activities for such Islamic banks this means all banking activity must be sha’riah compliant, a significant characteristic of this means interest is prohibited not only is this mentioned in the holy Quran as having bad affects on society but the main concept of Islamic banking is set upon the foundations of profit-sharing instead of being ‘interest based’ which is referred to as (Riba in Islam) which is highly known in conventional western banks in the UK such as NatWest, Lloyds tsb, HSBC etc. In a western bank system money will be lent/loaned to a customer with no real interest shown or involved in the outcome or business of the customer obviously some risk assessment would be considered but not to the extent of which risk would be shared, Ridzwa, (2004) states the difference within Islamic banking is that â€Å"cash/loans will not be given to the customer, first of all they purchase the commodity and transfer to client then all profit and loss will be distributed between parties according to agreed terms and conditions†. As Islamic banking is based strictly on Islamic ethics and Quran practices Bown, (2005) states this also means loans/investing in projects or businesses that have ‘haram’ significance which means forbidden activity in the holy Quran will not be invested upon for instance places that plan on serving alcohol or promote gambling and sexual influences like nightclubs will not be agreed to investments. Upon analysing the financial side of Islamic banking the clear principle it is financially based on for its trading activity is ‘the risk/gain is shared upon the provider of the loan (bank) and the expertise of business idea (customer)’ IBB, (2010) by this both parties have a mutual agreement for the bank the money they are providing is being lent with a risk but also an agreement with the customer to share of any profits. The commercial law side of Islamic banking is actually based on four basic principles (Bellalah and Ellouz, 2004) claim â€Å"the fundamental of first Islamic business principle is profit and loss sharing and the second is based on fixed service fees and charges and third is based on free of cost and no charges. T e other principles are changing with the situation of the business and its operation.† Methods of Islamic banking Islamic banking has many different methods and Islamic approaches to what a conventional/western bank would give out a mortgage/loan. Dar and Presley, (2000) state that the key banking methods Islamic banks use are Ijara, Mudarabah, Murabahah and Musharakah. Ijara: Is a form of rental contracts mainly for goods/property mortgaging it involves the sale and the transfer of assets title to the customer lending at the end of Ijara. In a banking scenario the Islamic bank would buy a property lease it to a customer for a fixed price till the agreed price has been met through lease/ijara then the customer will become owner of such asset’s a rent contract by which the owner of the good rents it to another party can also be part of this. According to the (IBB) Nowadays the Home Finance and Islamic mortgage are based on the concept of Ijara and it is very successful tool in Islamic financial system and popular amongst non Muslims too who are ever increasingly using this type of finance. Mudarabah: khan, (1993) states this form of finance is mainly known as profit sharing and involves a type of partnership agreement between two sides in this scenario the bank and the person lending the money (customer) the bank will provide the funds and the customer will provide the business venture and idea however all profits will be shared amongst both parties with an agreed fee. It can also be said some characteristics of western banking are still slightly involved with this type of financing as the entrepreneur must guarantee full refund in case of contract breaching and negligence. Murabahah: This type of banking is referred to as cost plus/mark-up sale this involves a sale of which he buyer (customer) offers to purchase a commodity at a price equal to its cost to the seller plus an agreed profit margin. â€Å"It is a trust or a transparent sale in which the cost of acquiring the goods by the seller must be disclosed. The cost to the seller includes the price he had paid plus all other expenses. Payment of price can be made against the delivery of the goods sold or deferred as lump-sum or instalments† Islamic bank of Britain, (2010). Murabahah usually starts with the buyer signing a promise to purchase. The seller then acquires the goods and takes their possession. Finally, the buyer signs the Murabahah sale contract and receives the good in return for payment or an obligation to pay later. It is one of the most popular modes used in Islamic banking system in different countries to promote interest-free transactions. Musharakah: this method of banking is mainly for mortgages similar to the ijara method with slight differentiations both have forms of agreements from both parties but difference in this method rather than rent instalments covering the cost to have full ownership of a property or goods instalment payments will be for shares of the product/property which once fully covered will fulfil full ownership to the customer giving them 100% ownership. Comparison of Islamic banking to western/conventional banking It can be said that Islamic and conventional/western banking Islamic and traditional banking actually are not different in what they supply but to how they supply such services Shahin, Z, (2004). Islamic banking has the same features as western/conventional banking and provides the same services as conventional banking for example current accounts, saving accounts, insurances, mortgages and investment opportunities in the society. Upon comparing Islamic banking and conventional/western banking for example like the Islamic bank of Britain compared to Barclays bank there some evident differences not only is the main one being that of the sha’riah law principles that are followed by the Islamic banks which therefore means business approaches in forms of investments, responsibility and product features will all be based upon the Islamic faith and must stay within the limits of Islamic Law or the Sha’riah. However other key significant differences in the two types of banking are factors such as interest, taxation, risk/profit sharing and the restriction of investments. Comparison towards the use of interest within Islamic banks and western/conventional banks: Lending money and getting it back with compounding interest is the main fundamental function for a western/conventional bank it is a main source of profit making for major high street banks in the United Kingdom almost sometimes criticised for their high rates of such interest. However this is in contrast to Islamic banking where interest is forbidden and deemed as Riba’ but a more partnership approach is given to the customer and agreed payments with profit sharing agreements set upon the provider and lender. When comparing the two methods the main difference here is that western/conventional banks follow the principle that interest is the price of credit, therefore reflecting the opportunity cost of loaning the money. Whereas in Islamic banking the creditor (bank) should not take advantage of the person lending the money as this in Islam is perceived as injustice where the first Islamic principle underlying for such kind of transactions is â€Å"deal not unjustly, and ye shall not be dealt with unjustly† [2:279], Holy Quran. Comparison of taxation and additional charges for Islamic banks and western/conventional banks: In the United Kingdom all organisations/businesses must pay tax commodities including Islamic banks and non Islamic banks however in Islamic banking such additional charges are approached with caution and compliance to sharia law and have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity which is known as ‘zakat’ claims often enough is welcomed by the Muslim population of customers as it is the Islamic term of charity. When comparing this type of additional zakat charge many western/conventional banks state this as normal VAT and APR charges which vary in price and cost from bank to bank it can be said for Islamic banking this type of charge still exists but named and dealt with differently in the form of zakat. Comparison of Risk sharing in Islamic banking and money loaning in a western/conventional bank: Islamic banking involves risk and profit sharing with the person lending the banks somewhat ‘forming a partnership feel with the customer’ Bhatti, I.M, (2008) which means Islamic banks are more involved with customer projects and pay greater attention in developing and appraising certain enterprises/projects where in comparison to western banks like Lloyds tsb where in a case study on Islamic and high street banks some customers who transferred from their branch over to Islamic bank of Britain branch stated â€Å"they felt the bank was only interested as seeing the customer as a debtor and themselves as the creditors†. When comparing the Western banks method of loaning/lending money such banks will often enough place a fixed rate of interest as part of the charge and will not really be as closely involved in the participation of the business venture as Islamic banks wou ld be due to the risk/profit sharing factor. Comparison on the restriction of investments for Islamic banking and western/conventional banking: as stated many of times throughout this report Islamic banking is strictly sha’riah compliant meaning all activities are in conjunction with Islam and the teachings of the Quran and the prophet Mohammed PBUH therefore all business investments/ventures must be deemed as ‘pure’ and accepted in the eyes of Islam for an Islamic bank to invest in Dixon, R. (1992) therefore any business proposals that are brought forward to an Islamic bank that consists of serving alcohol, promoting gambling and sexually influence will be strictly turned down. Where as in comparison to a western conventional bank plans will be accepted on the basis of good credit, business venture and the ability to pay back such fees. Challenges that Islamic banking may face within the United Kingdom: Islamic banking is becoming ever more popular in the United Kingdom with many non-Muslims also interested and joining the Islamic bank of Britain as customers but upon research and case study readings many people in Britain feel they don’t fully understand the concept of Islamic banking and that it should be made more user friendly for society. There is need to make a clear and transparent system of general as Islamic banking is in a transition development stage a key issue in Britain according to Khalaf (2007) Islamic banking industries have a barrier to overcome with the whole sha’riah law compliance being appealing to non-Muslims as many non Muslims can perceive this as influencing a ‘different law for a different country with a different religious view point’. Also opinions of Islamic scholars, suppose a product or practice may be accepted to one scholar, could be considered un-Islamic by another scholar. Malaysia has established a standard sha’riah board which is supported by government which in the united kingdom is not applicable and that the banks set these out themselves according to basic sha’riah compliance. (Khalaf, 2007) claims it is evident in Britain that Islamic banking faces many challenges with society and keeping up with such growth of western conventional banks due to its new growth in the UK market however with strong middle eastern financial backers such as Qatari national bank the Islamic bank of Britain is financially stable in this sense and that it is gaining more recognition amongst the Muslim popularity of Britain with many Muslim customers holding accounts with them but it can be stated a key challenge is the ‘Different beliefs in society make that some Islamic banking activity acceptable to one part of community and to others it is not’ . Conclusion Islamic banking in Britain now has great opportunity for growth as it offer certain benefits that conventional western banks do not put in place many Muslims feel this type of banking is relevant for their practice of religion whilst some may argue that costs such as interest also known as ‘Riba’ are still put in place just named and charged differently and then opt to carry on using such ‘western banks’ however it can be said great ethical value is taken into consideration in contrast to western banks and vulnerability and risk of business venture is shared and discussed which if western banks applied could see a great rise in popularity and custom however in the united kingdom the regulatory authority and structure of Islamic sha’ria practice can sometimes have setbacks for such Islamic banking activity as society may not accept this. Overall Islamic banking has great opportunity to grow because many numbers of muslims are residing in the united kingdom and there is a steady growth for such market, however it can be said if such rise of awareness and identity was put in place to market Islamic banking this could possibly promote it further and on the scale of such western banks. References: Bellalah, M. and Ellouz, S. (2004) Islamic Finance, Interest Rates and Islamic Banking Bokhari, F. (2007) Lloyds TSB spots growing appetite. Financial Times Bown, J. (2005) Islamic banking set to boom. Sunday Times Belder, R.T. and Khan, M.H. (1993) the changing faces of Islamic banking. International Financial Law Review Chris, Cook. (2006) is Islamic banking religiously sound? Financial Times Dixon, R. (1992) Islamic banking. The International Journal of Bank Marketing, Hassan, M.K. (1999). Islamic banking in theory and practice: Haron, Sudin (1995) The Framework and concept of Islamic interest-free banking