What does the Islamic Banking System do for the World?

23 December 2021

 

How, by enlisting Shariah norms, should people build relationships with each other? What is ‘pure money’ in Islam and the concept of ‘riba’? What is the original purpose of money and what are the advantages of introducing Islamic banking in the Russian Federation?


Recently, interest in the development of Islamic finance has increased significantly, including in Russia. This attention has reasons: today there is a fairly extensive practice of Islamic finance implementation: the industry has reached 2 trillion dollars and is present in more than 70 countries, including many non-Muslim countries. The growth rate of the industry is also encouraging: it reaches 15-20% per year and is much faster than the conventional financial sector, which is not more than 5% per year. However, it is regrettable to note that Islamic finance does not always conform to all the principles of Islam.


Muhammad Taki Usmani, Chairman of the AAOIFI Shariah Council, noted: ‘As long as the management, shareholders and customers of Islamic banks are not prepared to accept the difference in their concept of operations as compared to conventional banks – Islamic banks will continue to use operating principles alien to Islam, and genuine Islamic system will never be established’.
So what is the Islamic banking system like? What is its advantage over the conventional Western system? Prophet Muhammad warned His community: ‘If you start selling goods on credit and buying them back at a lower price (bai al-'inah), holding on to cows’ tails, being content with farming and ceasing to be diligent in the way of Allah, Allah will condemn you to humiliation until you return to your religion’.


The main provisions offered by the religious community are:


1.The conduct of economic transactions on the basis of clarity and ethics;
2.Risk sharing between financiers and customers;
3.Credit should consolidate the position of the borrower;
4.Not dragging the borrower into a debt trap;
5.Linking financing to the real economy.


Islamic finance is participatory, asset-backed, ethical, sustainable and socially responsible. This system implies the concept of risk sharing, connecting the financial sector to the real economy and universal access to financial services and social well-being.
Islamic banks have three sources of profit:


1.Musharakah, mudarabah and qard al hasan


Musharakah is integration of capital for financing. The profits are shared in a certain order. Mudarabah is an agreement between two parties, when one gives money and the other manages the project. Qard al hasan (in other words, a charitable loan) is an interest-free loan as a material aid or subsidy.


2.Long-term investments.


3.Commissions and leasing.


When referring to commissions, it is meant murabaha – an agreement between the bank and the customer to sell goods at a special price, which includes a margin – the difference between the purchase price and the sale price. Identical to murabaha is the bai bithaman ajil transaction, where the bank purchases equipment or goods at the request of the customer and subsequently sells them to the customer at a mutually agreed-upon price that exceeds the purchase price, which constitutes the profit of the bank. The customer can pay in installments, at a predetermined date, or pay the entire amount at once.


Another transaction of this kind is bai al-salam, or contract for the sale of goods, where the price is paid in advance and the goods arrive in the future. Once the bank has received the money, it can then invest it in production or in securities, allowing it to earn a certain amount of income, which constitutes the bank the profit of the bank on the transaction. It is also possible to pay gradually, that it the customer does not pay the bank the whole amount at once, but gradually – in installments. Such an operation is known in Islamic banking as istisna.


As far as leasing is concerned, this is about ijara. This is when the bank on behalf of the customer purchases and leases a certain object to the customer. A variation of ijara is the ijar wa-iqtin agreement, the only difference being that the customer undertakes to buy back the leased property from the bank at the end of the lease period.


The main principle of Islamic banking can be defined as following the precepts of the Quran. For instance, Islam prohibits riba (usury). Lending rate (riba) is also forbidden. One cannot finance immoral and unethical kinds of business (for example, alcohol, tobacco products), and the financing must be linked to real assets.


So what are the benefits of introducing Islamic banking? What are its advantages?


First of all, it is the mobilization of financial resources, especially in low-income countries. Here there is a special focus on working with small customers, and the Islamic bank plays the role of a socio-educational incentive. One should not forget about investment activities. The investment logic of Islamic banks follows the principle of increasing social benefit.


Special attention is paid to long-term projects that developing countries need. In parallel, there is financing for smaller projects. The returns on deposits depend on the performance of the companies in which the bank has invested its money. Thus, this creates a favorable investment climate and ensures that financial resources are efficiently allocated to the most profitable sectors of economy. As former IMF Executive Director Abbas Mirakhor noted, financing in accordance with the Islamic model would end the dependence of the real sector on the interests of banking capital.


Another important function of Islamic banks is to provide detailed information about their customers, unless it is a commercial secret. In addition to it, banks are called upon to preach and develop Islamic morality. As part of the Islamic model of economic development, the bank balances the material and spiritual principles and helps to maintain the balance between rights and responsibilities. Islamic bank should not only promote justice in Muslim society, but also consolidate society on the basis of a single religious idea.

 

 

Ilmira Gafiyatullina

Photo: Creative Commons