Islamic banking demystified

1. Is Islamic banking meant for Muslims only? Can a non-Muslim bank with you?

Islamic banking is consistent with a moral code set out by Islamic or Shariah law. This law includes the prohibition of investing in any business that goes against principles of Shariah law, like the selling of alcohol or gambling. This moral code is applicable to all and sundry of all religious beliefs.

2. What are the differences between Islamic and conventional banking?

a) Objectives

Islamic Banks: To achieve social as well as  financial goals and development of the Islamic community, subject to compliance with the rules of Islamic Shariah, without overlooking the element of earning profit.

Conventional Banks: Its main endeavour is to generate profit by charging its customers the highest possible interest without any regard to community development. It also acts as an intermediary between the lender and borrower with interest.

b) Principal Activity

Islamic Banks: It is characterised by special methods of investment of its funds according to Islamic Shariah principles such as sale and purchase, trading, murabahah, mudharabah, musharakah, salam, istisn’a, leasing etc.

Conventional Banks: It mainly concentrates on the grant of loans and advance payments in consideration of interest to be specified before hand (either lending with interest or borrowing with interest).

c) Lawful Adaptation

Islamic Banks: It can be a mudharib, musharik, owner of the capital, san’i, mustasn’i, seller, purchaser or operating in such other capacity.

Conventional Banks: They generally accept deposits from individuals and others and provide them as loans to individuals or third parties in which case the bank acts as an intermediary between the lender and the borrower, with interest charged on the principal as a general rule.

d) Guarantee of Profit and Loss

Islamic Banks: The Islamic banks do not play guarantor in respect of deposits except in cases of encroachments, negligence or violation of the terms or the custom of trade.

Conventional Banks: The conventional banks play guarantor because it borrows and lends with interest.

e) Social Solidarity

Islamic Banks: To achieve social solidarity through restoration of the religious duty of zakat by means of zakat funds, through interest free loan or allocation of funds for interest free loans with special terms.

Conventional Banks: The activities do not include any of the social aspects.

3. Can banks transfer credit balance of a customer's Islamic account to a conventional account, or vice versa?

It is always possible to transfer funds from an Islamic bank account to a conventional account upon customer request. On the other hand, only the principal amount can be transferred from a conventional account to an Islamic account. No element of interest is allowed to be transferred.

4. How do Islamic banks make a profit if they are not allowed to charge interest?

Islamic banks operate by making profit like any other business, though they avoid charging interest on loans borrowed by people. There are two ways to generate profit. One is by buying a product, like a house, and selling it to the customer at a higher price, allowing the fee to be paid in instalments.

Another way is where the bank and the customer buy a house together in partnership. The customer will then make payments that are partly meant for rent, and partly buying out the bank.

In fact these methods have often proved more profitable for Islamic banks than the methods of their counterparts. Whereas banks’ interest rates can rise and fall, the fee charged by Islamic banks remains the same regardless of economic changes.

5. What is the concept of Wadiah (safekeeping)?

For deposit product or Wadiah contract, a bank is the custodian and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of any part or the whole amount of the deposit when requested by the depositor. The depositor, at the bank's discretion, may be given hibah (gift) as a form of appreciation for the use of funds by the bank.

6. What is the concept of Mudharabah (profit sharing)?

Mudharabah is a form of partnership where one group provides funds and the other provides expertise and management. Profits that are accrued are shared between the two parties on a pre-agreed ratio, while the capital loss is borne by the fund provider. If fund providers are more than one, then loss is borne by them in proportion to their capital.

Rabul-Maal (Capital Investor)

In a mudharabah contract, the person who invests the capital is called rabul-maal.

Mudarib (Manager)

The entrepreneur or investment manager is called a mudarib who invests the investor's funds in a project or portfolio in exchange for a share of profits accrued.

7. What is the concept of Musharaka (joint venture)?

Musharaka means sharing. Technically, it is an investment contract whereby both parties contribute capital and enjoy an entrepreneurship together. They share profits on the agreed terms while the loss is borne by the parties according to the proportion of their invested capital.

There are two main kinds of sharika:

Shirkat ul-Melk (Co-ownership)

It is defined as the existence of an asset in the exclusive co-ownership of two or more people. In this type of sharika, each and everyone has undivided ownership even in the smallest part of the asset. This ownership is of two kinds:

a. Compulsory co-ownership

It is a partnership, which becomes effective without any action on the part of the partners, such as inheritance.

b. Optional co-ownership

It is a co-ownership, which is made effective through the act of parties e.g. joint purchase or joint acceptance of a gift.

Sharikatul-Aqd (Contractual Partnership)

Sharikatul-Aqd means an agreement between two or more parties to combine their assets, labour and/or liabilities for making profits. Following are the kinds of sharikatul-aqd:

a. Shirkat ul-Wujooh

Partnership between two or more parties whereby each partner contributes no capital but enjoy their creditworthiness in the society which helps them to obtain goods on credit, sell the goods and share the profit.

b. Shirkat ul-Abdan/ Sharikat ul-Taqabul

Partnership between two or more parties whereby each partner contributes the work and management (devoid of capital).

8. What is the concept of Wakala (agency)?

Wakala is a form of contract, whereby an individual delegates his right or business to other people to act as his agent or wakil (agent). The agent applies his knowledge and skills to complete the task assigned to his clients.

9. What is the concept of Qard (interest-free loan)?

The meaning of qard is 'to cut'. It is a loan offered on goodwill of the debtor, who is only required to repay the amount borrowed. In that case, the debtor does not have to pay an extra amount to the creditor and the transaction is termed as an interest free loan. Legally qard means to give a loan to the borrower, on the condition that the loan would be paid back on demand or at settlement.

10. What is the concept of Ijarah Thumma Bai' (hire purchase)?

This is a contract that begins with an ijarah contract for the purpose of leasing out the lessor’s asset to the lessee. Subsequently, at the end of the lease period, the lessee will buy the asset at an agreed price from a lessor by executing a purchase (bai’) contract. On the other hand, there are two contract executed in this concept. IjarahThummaBai’ is normally used in financing consumer goods, especially motor vehicles.

(Business Today / 01 June 2012)

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Alfalah Consulting - Kuala Lumpur:
www.alfalahconsulting.com
Islamic Investment Malaysia:
www.islamic-invest-malaysia.com