Entries in English and Malay (Bahasa Melayu)

Sunday, 13 July 2014

FAQs on Islamic banking

Ever since I started writing on Islamic Banking, I have been inundated with questions from Muslims as well as Non-Muslims, as to how it works, its significance, benefits & much more. I do understand that the concept is new and the discipline is not being taught yet, so even the banking professionals from our part of the world are intrigued to know its fundamentals. In a bid to address certain frequently asked questions, I have come up with this column, to make it easy for everyone, including myself. 

a) How is Islamic banking different from Conventional banking? 
'No interest' in Islamic finance is the major differentiating factor between the two. However, there are other important differences:
Islamic banking is asset-backed which means that an Islamic bank does not carry out business unless an asset is purchased to allow the transaction to be conducted according to Sharia.
The source of the Islamic bank’s funding, profits and business investments cannot be in/from businesses that are considered unlawful under Sharia, i.e. companies that deal in interest, gambling, pornography, speculation, tobacco and other commodities contrary to Islamic values.
The whole premise of Islamic banking is to provide a way for society to conduct its finances in a way that is ethical and socially responsible. Trade, entrepreneurship and risk-sharing are encouraged and these are the financial principles that underpin Islamic finance and the products offered by an Islamic bank.

b)  What is the need for me to switch to Islamic Banking? I don't take interest anyways.
The Qura'n and Hadith make it conspicuous that Riba is abhorred by Allah & His Prophet(SAW). Moreover, if there is an option where we are sure that our money is not misused in forbidden industries, it becomes our moral responsibility to opt for it. Even Non-Muslims call it ethical banking. Since Qura'n says "Allah has permitted trading and forbidden Riba." (2:275), Islamic banks generate wealth using trade agreements like Leasing, Investment & Partnership. Some Muslim customers stay with conventional banks and simply do not keep the interest they earn. Whether they know or not, indirectly, this can provide funding to other customers for activities that are not permitted in Islam, including interest-based lending. 
c) How do Banks ensure that their activities are permitted by Shariah?
Islamic banks have a Shariah Supervisory Committee (SSC) as well as Shariah Compliance Offices (SCO). All the financial products proposed, usually by the Marketing department, have to be studied and ratified by the SCO & SSC, to ensure compliance with the Shariah,

d) How can I purchase a House through Islamic bank when they cannot earn interest on it?
Usually, two principles of Islamic finance based on the Joint ownership & Lease agreement are employed.
In a plan of 15 years, the bank and the customer buy the property jointly. The customer then has 15 years to buy the Bank’s share for the same initial purchase price. This is based on the Diminishing Musharaka (diminishing partnership) principle of Islamic finance.
At the time of completing the joint purchase, the customer will live in the property even though a large share of it is owned by the Bank. Therefore, until the customer becomes the full owner, they will lease the portion of the property still owned by the Bank and pay a monthly rental to it. This is based on the Islamic financing principles of Ijara (leasing)
This way, the bank uses the Trade agreements with its client to make mortgage, Shariah compliant. However, if the customer takes more than stipulated time, to buy the bank's share, the Bank cannot charge him more since there is no time value of money in Islamic finance.
e) Are all the Islamic banks really Islamic?
No. There are many banks which use the term 'Islamic' to exploit sentiments of Muslims but they easily compromise on the principles of Shariah, as their main motive is commercial, to reach out to the Muslim markets. At the same time, it does not mean that Islamic banking as a concept is not viable. There are many examples where it is done the right way. 

d) How can we call it Islamic banking, when even the concept of Bank, as an institution did not exist at the time of Prophet(saw)?
The bank, as an institution, is a new phenomenon but not the financial dealings/transactions/principles. And if the Shariah rulings alter the current banking system in such a way that a new form of banking comes up, it would not be technically incorrect to call it an Islamic finance/banking. By the way, the nomenclature hardly matters. I think 'Shariah compliant finance' is more apt. Some call it 'Alternate finance' and others 'Participatory finance'. 

e) If it is based on Profit & Loss sharing, what if I lose all my money. Is my money safe?
Technically, one can lose money if the bank loses it, where it might have invested. However, the Islamic banking system uses real trading activities backed with real assets. This means that Islamic banks do not conduct business unless they have an asset to allow the transaction to be carried out. Islamic banks are also not permitted to use financial instruments that are based on speculation, which introduce a high element of risk to a bank, and the assets and deposits of its customers.
By following this asset-backed approach, Islamic banking as a whole, is not exposed to the same risks as conventional banks. This is why the Islamic finance industry proved to be an ethical and resilient alternative to conventional banking after the recent financial crisis. Moreover, they invest in their own home finance plan where the returns are assured. Some banks like Islamic Bank of Britain invest in low risk commodities like Metals. Till date, the banks have been able to make an estimated profit for their customers, without fail, as that is what keeps them afloat, in the market.
(Mehboob Makhdoomi is an MBA from Pennsylvania University (IUP) United States with a research degree from Cardiff University, United Kingdom.

(Greater Kashmir Srinagar / 13 July 2014)
Alfalah Consulting - Kuala Lumpur:
Islamic Investment Malaysia:

No comments:

Post a Comment

Latest Posts

Upcoming Events on Islamic Finance, Wealth Management, Business, Management, Motivational

Alfalah Consulting's facebook


Alfalah Consulting is NOT providing any kind of loan to finance project etc and asking for a fee. If you've received any email claiming to be from Alfalah Consulting, offering loan to you, please ignore it or inform us for further actions. Our official email is If you've received an email from, that's NOT from us. Be cautious!