Islamic Finance Elevated Dimension In Banking

The New Nation

Taifur Rahman :

Emergence of Islamic Banking system is an elevated dimension in the banking industry for the unique and welfare oriented approach. Currently, there are over 300 Islamic financial institutions (IFI) which are specially centered in the Middle East and Southeast Asia. Europe and the United States are also concentrating to Islamic Banking as well. Indonesia, Malaysia and Iran have attained top position in the Islamic Finance Country Index (IFCI) for the year 2019. It may be cited here that there has been positive changes in the IFCI scores for almost all the countries. Sudan, Pakistan, Bangladesh, Turkey, Egypt and the UK are potential leaders in the global Islamic financial services industry. This is widely known that Islamic Banks perform better during the crisis than Conventional Banks.

One key difference is that the formers don’t allow investing in the instruments that have adversely affected their conventional rivals and triggered the global financial crisis. These instruments are mainly known as derivatives and toxic asset. The logic of Islamic finance based on the pillars of Shari’ah is now being recognized for saving the banking sector from the worst impact of derivatives and toxic products. Islamic finance operates on the basis of actual need of the client in lieu of greed for earning more profit. Islamic banking operates in accordance with the rules of Shari’ah, known as Fiqh- al-Muamalat (Islamic rules on transactions).

The basic principle of Islamic Banking is the sharing of profit and loss (PLS) and the prohibition of Riba (usury), Gharar (uncertainty), Maisir (gambling) and non-Halal (prohibited activities). Mudaraba may be termed as Trustee Finance Contract. This is an agreement between the bank and an entrepreneur, whereby the entrepreneur can mobilize the funds of the former for its business activity. The rate of profit has to be determined strictly as an agreed percentage between the two parties. The entrepreneur has the absolute freedom to manage the business. Musharaka is Equity Participation Contract. The difference between Musharaka arrangement and conventional banking finance is that any kind of profit sharing ratio may be set but losses must be proportionate to the amount invested. Risk and reward are borne by both the parties concerned. Muzaar’ah is traditional counterpart of Mudaraba contract in farming where the harvest is shared between the bank and the entrepreneur. The bank may provide funds or land. Musaqat is traditional counterpart of Musharaka contract in orchard keeping. The harvest is shared among the partners based on their respective contributions. Musaka is the Arabic name for a financial certificate and it is called Islamic bond. The inherent beauty of this type of Islamic Bond is that fixed-income or interest is not permissible in this bond.

Sukuk is securities formulated in compliance with the islamic law and its investment principles which does not allow the charging or paying of interest. Qard al Hassan is Good (Benevolent beneficence) Loan with zero-return allowing only to charge the borrowers a service fee to cover the administrative expenses of handling the loan. Bai-Salam entails a contract in which advance payment is made for goods on condition 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 without ambiguity and dispute. The objects of this sale are goods except gold, silver or currencies. Barring this, Bai- Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship. Usually it is applicable to agricultural or manufactured products.

Lease Purchase implies a contract under which an Islamic Finance provides equipment, building, or other assets to the client against an agreed rental amount along with a unilateral undertaking by the bank that at the expiry of the lease period, the ownership in the asset would be transferred to the lessee pursuant to a sale or gift contract. Murabaha refers to the sale of goods at a price which includes an agreed profit margin by both of the parties. The purchase and selling price, other costs, and the profit margin must be clearly stated at the time of executing the sale agreement.

Islamic Banks are approximately similar to their conventional competitors in respect to the legal formation procedures. The exception is that they refrain from many transactions which are connected to trading in alcohol and tobacco production. In case of Islamic Banking system, the basis of the institution requires the presence of a special board called the Shari’ah Supervisory Board (SSB). This body has been termed as ‘the vital tool to evaluate, approve contract documents and supervise all operations of the bank in conformity with its objectives and ultimately with the principles of Islamic law’. The board consists of Islamic scholars who have background in Economics and Finance also. The role of this board is totally varied from the role of the board of directors although both of the boards assist each other to run the bank.

Islamic banking system is highly driven by certain ethical issues and prohibition of interest is a significant moral dimension in banking services. The key principle of Islamic Banking is to establish justice, equality and fairness based on certain values considering the needs of individuals. No concerned parties under the umbrella of the Islamic Finance have intention to exploit one another at the time of performing financial transactions. This is very frank that Islamic intermediation is entirely asset-based and centers on risk sharing. This eliminates and reduces the probability of default as there remains no fabricated transaction without any form of goods.

(Mr. Taifur works in a commercial bank. Email:


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