Islamic Banking for the Dummies
Since the beginning of the controversy on Islamic Banking, I have noticed one thing in all the discussion for and against. The argument in both ways is full of Ignorance, those who are against the banking can not fault the system objectively in anyway but the name “Islam”, while those for the banking those not even know how it is operated apart from the fact that it’s in compliance with Sharia and they do not give or charge Interest on its loan nothing more.
For the above reason, I extensively google the net and is able to create this note from my research and I hope it will be of great help and give those who are for the bank basis of enlightening those who are against, for indeed there are some who are ignorant and are ready to learn while others are nothing but BIGOTS.
I have tried as much as I can to simplify the note to the extend that even a dummy will fully understand it, enjoy your reading and be inform.
One must refrain from making a direct comparison between Islamic banking and conventional banking (apple to apple comparison). This is because they are extremely different in many ways. The key difference is that Islamic Banking is based on Shariah foundation. Thus, all dealing, transaction, business approach, product feature, investment focus, responsibility are derived from the Shariah law, which lead to the significant difference in many part of the operations with as of the conventional.
The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah in all of its actions and deeds. The original meaning of the Arabic word Shariah is ‘the way to the source of life’ and is now used to refer to legal system in keeping with the code of behaviour called for by the Holly Qur’an (Koran). Amongst the governing principles of an Islamic bank are :
On the other hand, conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.
Islamic law considers a loan to be given or taken, free of charge, to meet any contingency. Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle underlying for such kind of transactions is “deal not unjustly, and ye shall not be dealt with unjustly” [2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-creditor relationship.
The other principle pertaining to financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk.
Thus, financial intermediation in an Islamic framework has been developed on the basis of the above-mentioned principles. Consequently financial relationships in Islam have been participatory in nature.
Lastly, for the interest of the readers, the unique features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown below:-