The Islamic banking today has become most popular and reliable financial system in the world.

It appeared on the
world scene as active player over three decades ago. But as many of us know most of the principles which is based
on Islamic Banking , commonly accepted by the all over the world goes for centuries than the decades. Islam as a
religion very clearly prohibits the Riba -the interest, so the basic principle of Islamic banking is the prohibition of Riba
(Usury or Interest) base transactions

"Seek the other world by means of what Allah has bestowed upon you"
(28:77) The Holy Quran
_
"We must work our destiny in our own way and present to the works an economic system based on true Islamic concept
of equality of manhood and social justice"Quaid's concept of Islamic Banking [Opening Ceremony of The State Bank of
Pakistan on July 1, 1948]

The Origin of Islamic Banking

The origin of Islamic banks as major players in the financial domain was in the early 1970’s. But the rules
and regulations governing the Islamic banking system has been present in the world for more than
centuries.
The main pillar of Islamic banking is the forbiddance of Riba ( interest).
The principles that govern the Islamic banking environment are based on common sense and basic rules
and regulations. These sort of simple rules are the base of a band of religions in the world including Islam

While a basic occupant of Islamic Banking – the prohibition of Riba a term that encompasses not only the concept of
usury , but also that of interest -has rarely been recognized as applicable beyond the Islamic World, many of its
guiding principles have. The majority of these principles are based on simple morality and common sense, which
form the bases of many religions, Including Islam.
The Holy Quran clearly mentions about prohibition of Riba . The following verses will be able to taken as examples.
The Quran -Surah 02- Al Baqarah verse 275
“Those who devour Riba will not stand (especially for judgement before Allah) except as stands one whom Satan by
his touch has driven to madness. That is because they argue: “Business and Riba similar to each other.”But Allah has
made “business” Halal and He is made ‘Riba’ Haram. Those who after receiving this warning (concerning the Haram
of Riba) from their Lord, (now) desist (from Riba), may keep whatever they had previously earned (as Riba) ; and
their case (will now be judged by) Allah (alone ,i.e. the Islamic State will not deal with that matter); but those who
return (to Riba even after this revelation of the Quran ) are companion of fire (of Hell) ; they abide therein (forever).”

“ The Messenger of Allah Prophet Muhammed (Peace Be upon Him) cursed the one who takes (I.e.,Consumes)
Riba, the one who gives (I.e., Pays ) Riba the one who records the transaction , and the two witness thereof .He
said : They are all equally guilty.”
(Sahih Muslim)

“Abu Hurairah (Raliyallahu ) said that the Messenger of Allah Prophet Muhammed (Peace Be upon Him) said : Riba
is of seventy different parts , the least dangerous being equivalent to a man marrying (I.e having sexual intercourse
with ) his own mother .”
(Sunan Ibn Majah,Baihaqi)
So the basic principle of Islamic banking is as mentioned early is the prohibition of Riba , these verses of the Quran
and Hadith – saying of prophet Muhammed (Peace Be upon Him) are the pillars to this concept which clearly says to
avoid Riba.

During the middle ages Islamic finance was hugely popular and was widely accepted and practiced. It
helped in furthering the trade and business in the Muslim world. The Islamic merchants began to play a
very important role in the European region (Mediterranean, Spain and Baltic States) .The middle east
countries started playing a very important role in the trading scenario due to its location and soon became
an important trading and business hub thus increasing the importance of Islamic banking and financing.
It is also strongly believed that European financiers and businessmen improvised upon numerous
theories, concepts and techniques based upon the system of Islamic banking and finance .

The Shariah law clearly marks a demarcation amongst what is legal or halal and what is illegal or
haram.The law has numerous rules which a devoted Muslim is supposed to follow .It restricts taking
interest, pork , gambling , pornography etc..

Islamic banking refers to a system of banking or banking activity that is consistent with the principles
ofIslamic law (Sharia) and its practical application through the development of Islamic economics.
Sharia prohibits the payment or acceptance of interest fees for the lending and accepting of money
respectively, (Riba, usury) for specific terms, as well as investing in businesses that provide goods
or services considered contrary to its principles (Haraam, forbidden). While these principles were
used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a
number of Islamic banks were formed to apply these principles to private or semi-
private commercial institutions within the Muslim community

Principles
Islamic banking has the same purpose as conventional banking except that it operates in accordance with
the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of
Islamic banking is the sharing of profit and loss and the prohibition of riba (usury). Common terms used in
Islamic banking include profit sharing (Mudharabah), safekeeping (Wadiah), joint venture(Musharakah),
cost plus (Murabahah), and leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank
might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to
pay the bank in installments. However, the bank's profit cannot be made explicit and therefore there are
no additional penalties for late payment. In order to protect itself against default, the bank asks for strict
collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This
arrangement is called Murabaha. Another approach is EIjara wa EIqtina, which is similar to real estate
leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-
market price to the debtor and then retaining ownership of the vehicle until the loan is paid).
Bai' al 'inah (sale and buy-back agreement)
Bai' al inah is a financing facility with the underlying buy and sell transactions between the financier and
the customer. The financier buys an asset from the customer on spot basis. The price paid by the
financier constitutes the disbursement under the facility. Subsequently the asset is sold to the customer
on a deferred-payment basis and the price is payable in instalments. The second sale serves to create
the obligation on the part of the customer under the facility. There are differences of opinion amongst the
scholars on the permissibility of Bai' al 'inah, however this is practised in Malaysia and the like
jurisdictions.[28][29]

[edit]Bai' bithaman ajil (deferred payment sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit
margin agreed to by both parties. Like Bai' al 'inah, this concept is also used under an Islamic financing
facility. Interest payment can be avoided as the customer is paying the sale price which is not the same
as interest charged on a loan.

[edit]Bai' muajjal (credit sale)

Literally bai' muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks
that takes the form of murabahahmuajjal. It is a contract in which the bank earns a profit margin on the
purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in
installments. It has to expressly mention cost of the commodity and the margin of profit is mutually
agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or
higher or lower than the spot price. Bai' muajjal is also called a deferred-payment sale.

[edit]Musharakah

Musharakah (joint venture) is an agreement between two or more partners, whereby each partner
provides funds to be used in a venture. Profits made are shared between the partners according to the
invested capital. In case of loss, each partner loses capital in the same ratio. If the Bank provides capital,
the same conditions apply. It is this financial risk, according to the Shariah, that justifies the bank's claim
to part of the profit. Each partner may or may not participate in carrying out the business. A working
partner gets a greater profit share compared to a sleeping (non-working) partner. The difference between
Musharaka and Madharaba is that, in Musharaka, each partner contributes some capital, whereas in
Madharaba, one partner, e.g. a financial institution, provides all the capital and the other partner, the
entrepreneur, provides no capital. Note that Musharaka and Madharaba commonly overlap.[30]

[edit]Mudarabah

"Mudarabah" is a special kind of partnership where one partner gives money to another for investing it in
a commercial enterprise. The investment comes from the first partner who is called "rabb-ul-mal", while
the management and work is an exclusive responsibility of the other, who is called "mudarib".
The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capital and the
other party providing its specialist knowledge to invest the capital and manage the investment project.
Profits generated are shared between the parties according to a pre-agreed ratio. Compared to
Musharaka, in a Mudaraba only the lender of the money has to take losses.

[edit]Murabahah
Main article: Murabahah

This concept refers to the sale of goods at a price, which includes a profit margin agreed to by both
parties. The purchase and selling price, other costs, and the profit margin must be clearly stated at the
time of the sale agreement. The bank is compensated for the time value of its money in the form of the
profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a
vehicle), with a fixed rate of profit determined by the profit margin. The bank is not compensated for the
time value of money outside of the contracted term (i.e., the bank cannot charge additional profit on late
payments); however, the asset remains as a mortgage with the bank until the default is settled.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are common
in North American stores.

[edit]Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by the seller to
either costs or asking price. While the seller may or may not have full knowledge of the cost of the item
being negotiated, they are under no obligation to reveal these costs as part of the negotiation process.
This difference in obligation by the seller is the key distinction between Murabaha and Musawamah with
all other rules as described in Murabaha remaining the same. Musawamah is the most common type of
trading negotiation seen in Islamic commerce.

[edit]Bai salam
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The
seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance
price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be
purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods
and cannot be gold, silver, or currencies based on these metals. Barring this, Bai Salam covers almost
everything that is capable of being definitely described as to quantity, quality, and workmanship.
Basic features and conditions of Salam

1. The transaction is considered Salam if the buyer has paid the purchase price to the seller
in full at the time of sale. This is necessary so that the buyer can show that they are not entering
into debt with a second party in order to eliminate the debt with the first party, an act prohibited
under Sharia. The idea of Salam is to provide a mechanism that ensures that the seller has the
liquidity they expected from entering into the transaction in the first place. If the price were not
paid in full, the basic purpose of the transaction would have been defeated. Muslim jurists are
unanimous in their opinion that full payment of the purchase price is key for Salam to exist. Imam
Malik is also of the opinion that the seller may defer accepting the funds from the buyer for two or
three days, but this delay should not form part of the agreement.
2. Salam can be effected in those commodities only the quality and quantity of which can be
specified exactly. The things whose quality or quantity is not determined by specification cannot
be sold through the contract of salam. For example, precious stones cannot be sold on the basis
of salam, because every piece of precious stones is normally different from the other either in its
quality or in its size or weight and their exact specification is not generally possible.
3. Salam cannot be effected on a particular commodity or on a product of a particular field
or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit
of a particular tree, the salam will not be valid, because there is a possibility that the crop of that
particular field or the fruit of that tree is destroyed before delivery, and, given such possibility, the
delivery remains uncertain. The same rule is applicable to every commodity the supply of which
is not certain.
4. It is necessary that the quality of the commodity (intended to be purchased through
salam) is fully specified leaving no ambiguity which may lead to a dispute. ALl the possible
details in this respect must be expressly mentioned.
5. It is also necessary that the quantity of the commodity is agreed upon in unequivocal
terms. If the commodity is quantified in weights according to the usage of its traders, its weight
must be determined, and if it is quantified through measures, its exact measure should be
known. What is normally weighed cannot be quantified in measures and vice versa.
6. The exact date and place of delivery must be specified in the contract.
7. Salam cannot be effected in respect of things which must be delivered at spot. For
example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah, that
the delivery of both be simultaneous. Here, salam cannot work. Similarly, if wheat is bartered for
barley, the simultaneous delivery of both is necessary for the validity of sale. Therefore the
contract of salam in this case is not allowed.
Hibah (gift)
This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah usually arises in
practice when Islamic banks voluntarily pay their customers a 'gift' on savings account balances,
representing a portion of the profit made by using those savings account balances in other activities.

It is important to note that while it appears similar to interest, and may, in effect, have the same outcome,
Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot be 'guaranteed.'
However, the opportunity of receiving high Hibah will draw in customers' savings, providing the bank with
capital necessary to create its profits; if the ventures are profitable, then some of those profits may be
gifted back to its customers as Hibah.[31]

[edit]Ijarah

Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or service for
a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of
assets / equipments such as plant, office automation, motor vehicle for a fixed period and price.
Ijarah-wal-iqtina

A contract under which an Islamic bank provides equipment, building, or other assets to the client
against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of
the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the
promise does not become an integral part of the lease contract to make it conditional. The rentals as well
as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit
over the period of lease.

[edit]Musharakah (joint venture)

Musharakah is a relationship between two parties or more, of whom contribute capital to a business, and
divide the net profit and loss pro rata. This is often used in investment projects, letters of credit, and the
purchase or real estate or property. In the case of real estate or property, the bank assess an imputed
rent and will share it as agreed in advance.[30] All providers of capital are entitled to participate in
management, but not necessarily required to do so. The profit is distributed among the partners in pre-
agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital
contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).[citation needed]

Sukuk (Islamic bonds)

Main article: Sukuk

Sukuk, plural of ‫ صك‬Sakk, is the Arabic name for financial certificates that are the Islamic equivalent of
bonds. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are
securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit the
charging or paying of interest. Financial assets that comply with the Islamic law can be classified in
accordance with their tradability and non-tradability in the secondary markets.

[edit]Takaful (Islamic insurance)

Main article: Takaful

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to
misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to
be uncertain with respect to a very large number of similar individuals. Insurance by combining the risks
of many people enables each individual to enjoy the advantage provided by the law of large numbers.
See Takaful for details.

[edit]Wadiah (safekeeping)
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and
the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount,
when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with Hibah (see
above) as a form of appreciation for the use of funds by the bank.

[edit]Wakalah (power of attorney)

This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar
to a power of attorney.
Recent Trends
All the Islamic banks follow the basic rule of no interests, but each of them have applied it differently.
The difference mainly arises due to the due to the different laws in different countries, size of the banks,
goals of the banks and the type of customer it deals with, the competition it is getting from the foreign
interest based banks and several other reasons.
Some of the important aspects common to all the interest free banks are discussed in brief below:
Deposit Accounts consist of current, savings and investment. Accounts.
• Current/Demand Deposit accounts
Similar to normal banks, gives a guaranteed deposit.
• Savings accounts
There are multiple ways by which Savings deposit accounts can be operated. The money from the
depositors can be invested after taking required permission from the depositor. But the bank has to
promise to return the full amount back to the depositor. No fixed profit is promised by the financial
institutions to its customers .The savings accounts have stringent conditions to number of withdrawls and
minimum balance.But certain accounts which are used for investments have less strict conditions.The
return on capital is not ensured but banks invest carefully in marginally low risk-free short term projects.
• Investment account
It is a form of fixed deposit account where deposits are held for a fixed tenure and a profit or loss sharing
margin is accepted by both the parties i.e the financial institutions and the customer. Capital return is not
guaranteed.
• Modes of financing
Mainly differentiated under 3 broad based criteria’s: trade, investment and lending.
• Trade financing
Some of the different ways in which trade can be financed are
a) Mark-up price: In this case the bank purchases an item from a seller on behalf of the customer and the
customer has to repay the bank the price plus a profit which was agreed before hand. The customer has
the benefit of repaying the money later to the bank.
b) Letters of credit: The bank assures the import of a good on behalf of the client. The agreement is
based on marked up price or on the basis of profit sharing on sale of the items.
c) Hire-purchase: the financial institution will hire a good/item to the customer on a rent and tenure agreed
earlier.At the end of the tenure the customer gets the right of ownership on the hired good/item.Its like a
rental and at the end of the rental time the good is handed over to the customer.
d) Sell-and-buy-back: In this process the bank will purchase an item from the customer and give him
money for it.The condition will be that the customer will buy back the item on a predecided price after
some pre agreed time.
e) Leasing : the bank will lease an item to the customer for a pre agreed period and then the customer will
pay the balance of the price for the item and be the owner of the item.
• Investment financing can be done by three main ways:
a) Musharaka: Its like a joint venture. The financial institution will participate in the project along with the
enterprise.The terms and conditions for profit/loss sharing are finalized beforehand.The bank may slowly
come out of the project after recovering its investment and earning some profit.
b) Mudarabha : In this process the technology, resource management, labour management, expertise is
provided by the enterprise whereas the job of the bank is to provide full financial support.The sharing of
profits are finalized before hand but if a loss occurs then the total loss is endured by the financial
institution.
 c) Financing on the basis of an estimated rate of return: The bank will finance the project under the
assumption that the project will generate a minimum rate of return which will help in repaying the banks
investment.If the rate of return is more than the rate of return estimated by the bank then the enterprise
will gain from the excess profit.If the rate of return is lower than the expected return then the bank will
accept that only.The bank will share if any loss is endured in the project,.
• Lending
The different forms of lending are:
a) No interest is levied on the loan but the loan comes with a service charge.The interest costs are
covered through the help of this service charge.The service charge is predetermined by the Shariah
committee in the bank .This service charge varies from bank to bank.
b) Loans which do not bear interest or service charge.This are known as No-cost loans.According to the
rule each bank is expected to set aside a part of their funds to serve the society.No-cost loans are
provided to the needy and deprived people for setting up small businesses, farming , fishing etc.
c) free of charge overdrafts are provided up to a certain limit.
• Services
Different services such as bill collections,forex,money transfers etc are provided on a basis of
commission or charge.
Pakistan Islamic Industry –Where are we today?
3. Although Pakistan is a late starter to systematically promote IF relative to few
other
countries, growth in its IF-industry is substantive. Today Pakistan has
_ 6 full fledged Islamic banks; 4 operational
_ 13 conventional banks with Islamic banking branches
_ Over 150 total licensed Islamic banking branches in 25 cities & town
_ Rs109 billion (US$ 1.82 billion) in assets (2.8%); PKR 79 billion (US$ 1.32
billion) in deposits (2.7%) – as of 2nd December, 2006
_ 2 licensed Takaful companies
_ Half dozen Islamic mutual funds (IsMFs) with total assets of over Rs7 billion
(US$ 0.12 billion)

_ Established Mudaraba Sector

Conclusion
27. Central Bank is committed and is strengthening itself to offer different types of
services
and support to IF-industry. Aside from laying forward direction of the industry
growth and its
composition, SBP will be enhancing its capacities and developing initiatives to steer
the
industry from niche market to mainstream Islamic finance by aligning further its
administrative
structure and prudential regulation and supervisory framework to Shariah
principles.
28. For this purpose we have set up a matrix reporting and interaction mechanism
whereby
the dedicated Islamic Development Department under the Development Finance
Group will
interact and develop capacities of regulators in BPRD and inspectors in BID. Central
Bank will
set up a fund with support of the grant funding from aid agencies to help us further
enhance
financial sector innovation and develop capacities of our development staff,
regulators and
inspectors as well of high caliber industry staff. While these domestic initiatives are
underway,
SBP will work with Islamic Financial Services Board to work towards better
understanding and
resolution of the broader specific issues facing the industry as a whole. Pakistan
would have a
unique opportunity to play a significant role in this area as it works more closely
with IFSB in
coming years.