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Principles Of Islamic Banking Essay

1686 words - 7 pages

* Principles of Islamic banking
Islamic banking refers to a system or banking activity that is consistent with the Islamic jurisprudence [arab. fiqh] based on the principles of the Sharīʿah. Literally, it may be translated with “Path to the water of source”, rendering the “right” way that Allah has carved out for all Muslims. Main sources of the the Sharīʿah are the Qur’an and the Sunnah. Basic aims of the Sharīʿah are the spread of wisdom and welfare through transferring faith including beliefs and practices. In addition, in the past centuries Islamic religious scholars and jurists have been developing its practical application [arab. fatwa] to a system of instructions; some of them find ...view middle of the document...

These are Surah al-Baqarah (Chapter 2, verses 275-81); Surah al Imran (Chapter 3, verses 130-32); Surah al Nisa (Chapter 4, verse 161), and Surah al-Rum (Chapter 30, verse 39). According to Iqbal (2006) there are three distinct views on riba among Islamic scholars. Liberal view narrows riba to usury only and does not see the necessity of a change in the existing financial system in which interest is essential. The mainstream view defines riba also as bank interest and claims a reorganisation of the whole financial system. The conservative Islamic scholars widen the definition to social injustices like low living, demanding a radical change of the whole economic system in preference to Marxian philosophy. In 2002 the al-Azhar Institute of Islamic jurisprudence issued a fatwa [arab.fatwā] that dealt with the bank-depositor relationship and the legalization of a fixed profit percentage on saving accounts. The majority of jurists involved in Islamic finance strongly opposed and denounced this fatwa. Islamic banks do not charge interest, but it does not mean that capital is not to be rewarded or that risk is not to be priced. The concept of interest is replaced by the profit-loss-sharing- and mark-up principle. Instead of charging interest, the bank shares profit and loss from the use of its funds. Islamic bonds [arab. sukuk] pay annual profit rates. For certain services like trade financing or in cases of delayed payment the banks debit a mark up as compensation. Depositors of current accounts do not receive any compensation however saving deposits are fixed term profit-sharing arrangements that are cashed at maturity. The implications of riba in a foreign exchange market allow only spot transactions between two currencies, when transactions are done simultaneously. Another tenor in Islamic Finance is the prohibition of gharar [arab.gharār]. According to professor Mahmoud A. El Gamal (1999) gharar has the meaning of “risk” or “danger of loss”. The Encyclopaedia of Islamic Jurisprudence (2010) also lists “cheating” and “fraud” as special cases of gharar. The basic appellate of this prohibition is to prevent insecurity that is not reasonable. A contract upon a good that is not existent at the day of sale is not valid due to the prohibition of gharar. Khan (1988) states that according to the Islamic point of view, basic operations in a forward market are lawful. It is argued that arbitrage stabilizes the markets and hedging helps traders to manage their stocks efficiently. This point of view is accepted by the majority of Islamic scholars. However, it is important to see the purpose of each financial activity. In example, derivatives are used for two purposes: Hedging and Speculation. Hedging techniques are allowed as long as they are Sharīʿah-conform (e.g. the underlying asset needs to be halal [eng. allowed]). Conventional derivatives such as options, futures or swaps are strictly prohibited. Islamic scholars are aware of the fact that speculation...

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