Introduction Of Islamic

Banking
 Introduction of Islamic
Banking
Islamic banking is interest free banking, in
which there is no fixed rate of return. Islamic
banking is the banking system which is run in
accordance with the Islamic laws and the
Shari a` board; that guides the institutions.
This Shari a` board authorizes the products
that whether these are Shari a` compliant or
not. Islamic banking is the banking that is
guided by Islamic law ( Shari a`) principles
and guided by Islamic economics. In
particular, Islamic law prohibits usury, the
collection and payment of interest,
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also commonly called Riba in Islamic
discourse”. Islamic banking also finds its roots
in Islamic finance and all type of transactions
are interest free and of risk sharing. The
interest is prohibited in Islamic ways of
banking as it is also obvious from Quran. In
Quran, in Sura Al-Imran, Allah said that; “O
you who believe! Do not devour Riba
multiplying it over and keep your duty to
Allah that you may prosper” (3:130). Same
kind of prohibition regard fixed interest is also
lead in Sura Al-Rum(39) , Al-Nisa(160-161)
and Al-Baqarah(275-281) of Quran.

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Riba and Gharar are illegal under
Islamic law. Riba refers to fixed rate of
interest. Gharar refers to speculation.
Islamic banking shows dramatic
improvements and developments in
Pakistan. Islamic banking is taken as
national policy and it is supported but
there exist dual banking structure in the
Muslim countries. Mostly the banks of
conventional system are also opening
their separate Islamic banking divisions
and branches.
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The expectation of increase in growth
of networking of Islamic banking
system is increasing. The Islamic
banking has increased in terms of
branches, deposits, capital funds,
sources. The ratio of income to
expenses is high which indicates
increasing profitability of the sector.

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 Riba or Interest
Riba literally means increase, addition,
expansion or growth. It is however not
every increase or growth, which is
prohibited by Islam. In shariah, Riba
technically refers to the premium that
must be paid without any consideration.

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 Types Of Riba
According to jurists of Islam Riba have two
types.

 Riba Al-Naseah
 Riba Al-Fadl.

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The organization of term interest dates
back to 17th century with the
emergence of banking system at global
level. Interest means giving and/or
taking of any excess amount in
exchange of a loan or on debt. Hence,
it carries the same meaning/ value as
that of Riba is defend in the previous
question. Further, it is narrated that “
the loan draws interest is Riba”.

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 Riba in Quran
 In the Holy Quran, Allah (SWT) says in Sura
Al-Baqarah (2-279):
“……. And if you repent, yours is your
principal”
 And what ever Riba you give so that it may
increase in the wealth of the people, it does
not increase with Allah. ( Sura Al-Rum 30:39)
 And because of their charging Riba while they
were prohibited from it. ( Sura An-Nisa 4:161)

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O you who believe! Be mindful of God and give up
what remains of al-riba if you are believers. If you
do not do so, then receive a declaration of war
from God and his Messenger. But if you
repent, you shall have your capital sums
(ru`us al-amwal). You do not deal unjustly
and you are not dealt with unjustly (2:278-
279)

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 Riba in Hadith

"Every loan that derives a benefit (to the creditor)

is riba."
This Hadith is reported by Hazrat Ali Radi-AllahuAnhu

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 Abu Said al Khudri Radi-AllahuAnhu narrated
that Holy Prophet( peace be upon him) said:
“ Gold for gold, silver for silver, wheat for wheat,
barley for barley, dates for dates, and salt for salt,
like for like, payment made hand by hand. If
anyone gives more or asks for more, he has dealt
in Riba. The receiver and giver are equally guilty.

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If the creditor received a goat as mortgage from
the debtor, the creditor may use its milk to the
extent he has spent in providing fodder to the
goat. However, if the milk is more than the price of
the fodder, the excess is riba." Usmani, para 99)

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 From Usamah ibn Zayd: The Prophet,
peace be on him, said: "There is no riba
except in nasi'ah [waiting]." [Bukhari,
Kitab al-Buyu, Bab Bay al-dinari bi al-
dinar nasa'an, #386; also Muslim and
Musnad Ahmad]
 "There is no riba in hand-to-hand [spot]
transactions." [Muslim, Kitab al-
Musaqat, Bab bay'i al-ta'ami mithlan bi
mithlin; also in Nasa'i].

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 Difference between
conventional banking and
Islamic banking

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 money
Bank Client

money + money (interest)

Conventional
Banking System

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Bank Goods & Client
Services

money

Islamic Banking
System

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 Conventional Banks Islamic Banks
Money is a commodity besides medium of Money is not a commodity thought it is
exchange and store of value used as a medium of exchange and store
of value

Time value is the basis for charging interest on Profit on trade of goods for charging on
capital providing service is the basis for earning
profit

Interest is charged even in case the Islamic bank operates on the basis of
organization suffers losses by using bank’s fund profit and loss sharing

While disbursing cash finance, running finance The execution of agreements for the
or working capital, no agreement for exchange exchange of goods & services is a must
of goods & services is made. while disbursing funds under Murabaha,
salam & Istisna contracts

Conventional banks use money as a commodity Islamic banking tends to create link with
which leads to inflation the real sector of the economic system by
using trade related activities.

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 Conventional banks Islamic Banks
The investor is assured of a pre determined In contract it promotes risk sharing between
rate of interest provider of capital (investor) and the user of
funds (entrepreneur)

Lending money and getting it back with Compounding calculation is strictly prohibited
compounding interest is the fundamental under Islamic banking system
functions of the conventional banks

It can charge additional money incase of The Islamic banks have no provision to charge
defaulters any extra money from the defaulters.

Conventional banks invest their deposit in Islamic banking only deals in Halal products
interest based modes and services, all transactions must be in
SHARIAH COMPLIANCE

The status of a conventional bank, in The status of Islamic bank in relation to its
relations to its clients, is that of creditors clients is that of Partners, Investors, and
and debtors. Trader, Buyer and Seller.

A conventional bank has to guarantee of all Islamic banks cannot guarantee of all its
its deposits. deposits.

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Basic Principles of Islamic
Banking

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 Sanctity of contracts.
 Risk sharing.
 No Riba / Interest.
 Economic purpose / activity.
 Fairness.
 No valid subject matter.

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Shariah / Islamic Law

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Shariah lexically means a way or path.
In Islam Shariah refers to the divine
guidance and laws given by the Holy
Quran, the Hadith (sayings) of the
Prophet Muhammad (peace be upon
him) and supplemented by the juristic
interpretations by Islamic Scholars.
Shariah embodies all aspects of the
Islamic faith, including beliefs and
practices.
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 Sources of Islamic Law
 The Holy Quran

 The Sunnah of the Holy Prophet (peace be upon

him)

 Ijma’ ( consensus of the Ummah)

 Qiyas (Analogy)

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Islamic Mode of Financing

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 Contracts
 Mudarabah
 Murabaha
 Musawamah
 Salam
 Istisna
 Ijarah
 Ijarah wa Iqtina ( Ijarah Muntahiyyah
Bitamleek)

Sub Contracts
 Wakalah
 Kafalah
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Islamic Banking Fare vis-à-vis
Conventional Banking
 The approach of Islamic banking to satisfy
the business needs of the customers is
entirely different from that of the approach
adopted by conventional banking. Basically
Islamic banking satisfies the business needs
of the entrepreneurs by the following two
methods.

 Profit and loss sharing modes

 Debt creating modes (financing the purchase

of commodities onBy:credit
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 Role of Islamic banking in
Economic Development of the
Country

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 Principles Governing

Islam

Aqidah Shariah Akhlaq

(Faith and Belief) (Practices and Activities) (Moralities and Ethics)

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While functioning within the Shariah
framework, Islamic banks an perform a
crucial task of resource mobilization and
efficient allocation using either profit sharing
(Musharakah and Mudarabah) or trading &
Ijarah based categories of Islamic mode of
financing. Profit sharing modes can be used
for short, medium and long-term project,
financing, import financing, pre-shipment
export financing and working capital financing
transactions. In order to ensure maximum
role of Islamic finance in the development of
economy it would be necessary to create an
environment which may induce to earmark
more funds for Musharakah/Mudarabah based
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Small and medium enterprises (SME) sector
has a great potential for expanding
production capacity and self-employment
opportunities. Enhancing the role of financial
sector in development of SME sub-sector
could mitigate the serious problems of
unemployment and low level of exports.

it can safely be said that Islamic banking has

a great potential of playing an effective role
in the development of the country.

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Is Islamic Banking Viable

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Islamic banking is still in the stage of
evolution. No one can disputes that there is a
definite desire amongst Muslims savers to
invest their savings in the venues which are
permitted by the Shariah. Nevertheless, they
must be provides with Halal returns on their
investments. Islamic scholars and practical
bankers took up this challenge and have
made commendable progress in the last few
decades in providing a number of such
instruments. However, the concepts of Islamic
banking and finance are still in their early
stages of development and Islamic banking is
an evolving reality for continuously testing
and refining those concepts.
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Nature of Deposits in Islamic
Banks

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Following are the nature of deposits
in Islamic banks.

Deposit Nature
Current Qarz
Saving Mudarabah

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 Qarz can be use for own need and amanah
can not be used for any purpose, that’s why
Islamic banks current accounts are based
on Qarz and not in amanah.
 Islamic banks offered three types of saving
accounts.

Mudarabah Saving Account

Musharakah Saving Account
Wakalah Saving Accounts

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ISLAMIC BANKING AS AN
ALTERNATIVE APPROACH

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One might wonder whether Islamic banking and
finance is an alternative approach to modern
banking. In fact, the banking business is no more
than a possible means to satisfy the needs of society
according to the prevailing conditions and
circumstances. Those needs should always govern
the means, not be its subject. The most important
development in modern banking is the art of
mobilizing funds for investment. It happened to be
that the method of both collecting and using of
funds was based in the West on interest paid and
charged. In contrast, Islamic banking
is a system that provides financing and attracts
savings on the basis of profit/loss sharing. One may
have to think positively of such a scheme. By
waiving the interest factor, we find an alternative
vehicle to provide financing on a different basis
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 For Muslims, this system of profit/loss
sharing coincides with their belief in the
prohibition of interest, and helps in
mobilizing unused funds for investment and
creating new job opportunities.
As for non-Muslims, the Islamic banking
system does not contradict their faith, while
it provides the society with alternative ideas
for venture capital and other tools of
investment.
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Mudarabah as a contract of participation between
the provider of capital and the managing
entrepreneur responds to normal human needs. An
enterprising engineer living in the West, as an
example, would welcome any possibility that
enables him to be provided by venture capital to
establish a new factory. This could be the case with
many individuals of the same spirit. The ultimate
test of such alternative is whether it is successful or
not. It can be safely said that the idea of Islamic
banking has been successful. It is, therefore, not
surprising to find several international banking
institutions started the establishment of Islamic
units or windows for some of their customers.
Islamic banking was partially practiced by some of
the Western banks and financial institutions in
Switzerland, U.K. Prepared
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The establishment of City Islamic Investment Bank
in Bahrain is the latest example for the possible
adoption of the Islamic banking system by
traditional bankers. Economists have proven that
the wider is the freedom of
choice the higher is the level of social welfare. In
addition, wider choice implies greater respect of
human rights. When an alternative concept such as
Islamic banking is introduced, a new choice is open
to the market, with obvious economic and social
benefits. Introducing Islamic banking as a new
choice has also further benefits related to the
advantages it provides to many fund users.
Commodity and service producers would certainly
appreciate equal opportunities for obtaining capital
based on the merits of their businesses
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rather than on their personal creditworthiness
alone. Those entrepreneurs who prefer to be self
employed need ways to obtain financing other than
borrowing. Islamic banking gives those pioneers
such an opportunity on the basis of profit/loss
sharing. In general, Islamic finance places more
weight on the merit
of the business to be financed, rather than the
wealth of the fund user. As a result under this new
banking alternative, a better distribution of credit
may be achieved. Therefore, I would like to
recommend strongly to the Western World that all
obstacles remaining in the way of establishing
Islamic banks in their countries be removed.
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CHALLENGES AND
PROSPECTS

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Last but not least, I would like to conclude with a
word about the challenges facing Islamic banks and
what prospects they may have. The biggest
challenge Islamic banks have faced from their very
beginning is how to narrow the gap between the
Islamic banking model and its application; in other
words, between theory and practice. Difficulties
arise in this respect come from being relatively
small in a traditional banking environment, having
to rely on bankers trained in traditional banking,
and attempting to balance the unquenchable
enthusiasm on the side of depositors, with a limited
supply of investment opportunities.

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Islamic banks have been trying hard to meet those
challenges through several means. The first is to
work for a better understanding of the concepts
upon which their operations are based. This has
been a success to the extent that now traditional
bankers are mostly cooperative and
accommodating. Central bankers have also come
forward with new ideas of better methods for
supervision and control, to suit the operations of
Islamic banks. Another means is to train their staff
in this new form of banking and to press for more
banking and financial innovations which are
necessary for the new modes of finance.
Fortunately, financial engineering has come in
handy with bold and new ideas in finance which
made the Islamic model so much more applicable.
Innovations in this regard
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Islamic banks. Surprisingly, financial markets
produced some useful innovations, perhaps
indicating that Islamic banking is an idea whose
time has come. Nonetheless, many challenges still
remain, not the least to the predominance of
Murabaha (sale mode) in the operations of some
Islamic banks, as well as the relative scarcity of
short-term Islamic financial instruments. The
prospects of Islamic banking and finance will depend
extensively on the ability of Islamic banks to
continue facing challenges with resourcefulness and
creativity, in addition to being worthy of trust and
understanding. I believe that competition, if allowed
and maintained, not only within Islamic banks, but
also between all banks whether Islamic or
traditional, would insure a promising future for the
banking industry Prepared
as aBy:whole.
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Growth of Islamic Banking in
Pakistan

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Focus Areas

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Worldwide Statistics

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Market Performance

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