ISLAMIC BANKING: GENERAL OVERVIEW

In the Name of Allah, Most Beneficient Most Merciful

ISLAMIC BANKING:
................................. GENERAL OVERVIEW



Oh believers, take not doubled and redoubled interest, and fear God so that you may prosper. 

Al-Qur'an



INTRODUCTION

Islamic banking refers to a system of banking, which is consistent with Islamic Shari’ah (Law), and guided by Islamic economics. Islamic law prohibits the payment and collection of riba (interest or usury).The main argument against interest is that money is not used as a commodity with which to make a profit but that it should be earned on goods and services only, not on control of money itself. Features of Islamic Banking are based on ethical principles. Islamic Shari’ah allows all economic activities in the framework of protecting public interest and safeguarding it. Man may make profit from doing business. However, when this runs against Islamic ethics and morality, it is outlawed. In addition, for an investment to be legitimate, one of the most important requirements is that its outcome must fulfil the reality of investment transactions and that it enables the Islamic Financial Institution (IFI) to state what it expects to make in profits. However, this cannot be determined as a certainty or can one commit one’s self to it, or bear any loss sustained.

Main conditions governing Islamic investment include: Money does not generate or beget money in itself, but it becomes productive if it is involving an activity or work; Investment is subject to the rule of profit and loss sharing; Investment in business activities is lawful, but prohibitions should be avoided. ;Contracts must be free of gharar (uncertainty, ignorance and the conditions which lead to disputes).

RIBA (USUARY / INTEREST)

The Islamic Economic System revolves upon the prohibition of Riba (interest).

What is Riba?

     What does the Qur’an tell us about Riba?
     What does the Hadith tell us about Riba?
     What is the difference between interest and Riba?
     Why are Muslims forbid from taking/accepting Riba?
     Is Riba-free banking a reality?
     What is Haram/Halal in business transactions?
     Is Islamic banking possible in a non-Muslim society?
     Is Islamic banking open to non-Muslims?
     What is the difference between Islamic and Conventional banking?
     What is the way forward in Kenya?
     What can we learn from the experience of others?

The two main types of usury to be avoided are as follows:

Riba al-Nasiah
Riba al Nasiyah defined as: “any excess compensation over and above the principal which is without due consideration.”
The Prophet (SAW) said:

“Every loan that draws interest is Riba”
»Ali ibn Talib).

Riba al-Nasiah, or deferred usury, is related to extension of the repayment period for additional payment of money. It is also called Riba Jahiliyyah which was a pre-Islam form of usury and the worst of its kind.

Riba al-Fadl
Riba al-Fadl means the excess which is taken in exchange of specific homogenous commodities, such as selling gold with another gold, whereby one has more “weight” than the other.

“Oh believers, take not doubled and redoubled interest, and fear God so that you may prosper.”
Qur’an

The Prophet banned all interest based transactions as well as cancelling all interest due to and from the people of Taif condition of the Taif Treaty.

PROHIBITION OF RIBA IN ISLAM

The Islamic Economic System revolves upon the prohibition of Riba.

Riba in the Qur’an

First Revelation:

“That which you give as interest to increase the peoples wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold”(30:39)
Surah Al Rum, verse 39

Riba from Surah Al Baqarah

“Those who benefit from interest shall be raised like those who have been driven to madness by the touch of the devil; this is because they say: “trade is like interest” while God has permitted trade and forbidden interest.”
Qur'an, 275.

God deprives interest of all blessing but blesses charity
Qur'an, 276.

“O believers fear Allah and give up what is still due to you from interest (usury), if you are true believers.”
Qur'an, 278.

“If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it”. 279 “O Believers, take not doubled and redoubled interest and fear God so that you may prosper”
Surah Al Imran, 130-1.

Riba in the Hadith

The Prophet (SAW) said:

“Cursed is the receiver and the payer of interest, the one who records it and the two witnesses to the transaction. They are all alike in guilt.”
»Jabirbin Abdalla(Muslim/Tirmidhi)

Prophet’s Last Pilgrimage

Jabir bin Abdalla(RAW) giving a report on the Prophet’s (SAW) farewell pilgrimage said:

“The Prophet (SAW) addressed the people and said “All the Riba of Jahiliyyah is annulled. The first Riba that I annul is our Riba, that accruing to Abbasibnal Muttalib (Prophets uncle); it is cancelled completely”
»Muslim –Kitabal Hajj, Babb Hajjatial Nabi.

The Prophet's Vision During Miraj

The Prophet (SAW) said:

“On the night of Ascension, I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gibril who they were. He replied that they were people who had received interest.”
»(IbnMajah, MusnadAhmed)

PRINCIPLES OF ISLAMIC BANKING

Islamic Banking is based on the principles of trade, partnership, sharing of gains and losses, and prohibition of reckless risk. It prohibits:

     Interest-based banking
     Gharar –unclear contracts
     Maysir–speculation
     Financing of haram transactions -– alcohol, gambling, pork, etc.

Lending in Islamic Banking

Islamic Financing involves a buy-sale deal or a rent to sale deal. There is always an underlying asset behind the deal. Allah reminds us: “We have permitted trade and forbidden riba”. In Islamic banking, the lender must share the risk with the borrower.

Types of Lending contracts

     Murabaha – sale contract
     Mudaraba – Part financing
     Musharika – Partnership
     Ijara – rental/lease
     Tawarruq – overdraft facilities.
     Istisna’a
     Salam

Murabaha

The term Murabaha comes from the Arabic word “rabh” which means profit (Short term trade financing). Client identifies goods which we wishes to buy for KShs. x and requests a bank to finance the transaction. The Bank buys the said goods and resells them to the client for KShs. x+ margin (e.g. 10% agree profit).The Client then repays within agreed timeframe.

Musharika

This is a joint enterprise formed for business where all the partners (Bank and customer) contribute capital and share the profit according to a specific ratio while any possible loss is in turn shared according to the capital contribution by the two parties. Both the bank and the client contribute capital, client brings know how. Profits/losses are thus shared on agreed ratios.

Musharika vs Interest Banking

The characteristics of Interest Based banking are:

     Fixed Rate of Return percentage
     Bank does not take any share of loss/risk
     Banks not invoved in owning and selling of goods.

Mudaraba

This is a partnership where the bank contributes 100% of the capital and the client contributes know how. Profit is in turn shared on an agreed ratio. If there are any losses, the bank absorbs it fully. This is the equivalent to 100% financing by the bank.

Uses of Musharika/Mudhariba

     Short/medium/long term financing
     Project financing
     SME set up
     Import financing
     LC’s
     Export (Pre-shipment Financing
     Working Capital Financing.

Diminishing Musharika

This is where a client wants the bank to finance and remain a partner. The Diminishing Musharika/Murabaha is where the client buys out the shares of the bank over time. The classic examples is for example, the purchase of houses, equipment etc.

Ijara

Ijara is the same as leasing. The bank purchases the asset/house. There is Joint ownership between the bank and the client. The client rents it from the bank. Client enters into an agreement to buy the shares from the bank over an agreed timeframe. He then buys out small amounts of shares from the bank time to time ending up with a hundred per cent (100%) ownership. Repayment is in the form of rental costs which changes as the percentage owned by the client increases. The value of the asset can also increase thus the bank has the right to charge a higher price for the sale of its shares.

Istisna’a

Istisna’a is a sales transaction where a commodity is sold before it comes into existence. For example this mode of financing may be used for home financing where the client owns land and seeks financing for the construction of a house, the financier can provide him with a constructed house on a specified piece of land. The price must be fixed with the consent of all parties involved. All other necessary specifications of the commodity must also be fully settled. The payment of an Istisna’a may be made in advance or instalments or in a lump sum at the end of the period.

Salam

Salam is a sales transaction where a commodity, usually horticultural or agricultural goods, is sold before it comes into existence. The price of the commodity must be paid in advance to make the transaction valid.

Deposits in Islamic Banking

Clients deposits fall under the category of qard(Loan) to the bank and the bank is obliged to pay back. These loans fall under the category of Musharika. The bank is obliged to share in the profits of the bank with its depositors. Bank must protect these assets on behalf of its clients as well as get them the highest halal returns. Since banks do not pay interest, clients must therefore become a partners or Mushariks to share in the profits. The only way to become a partner is to open an investment account (Time or Saving Deposit) which allows the bank to invest one’s money. Profit sharing is then calculated and distributed. Profits will be very close to prevailing deposit rates.

Types of Accounts in an Islamic Financial Institution (IFI)

In Islamic banking each customer is a partner with the Islamic Financial Institution (IFI). This relationship is classified as a Mudarib Partnership. Profits resulting from the account are divided between the parties. An IFI receives a certain percentage of the net profits, as a return for the amounts deposited in different investment accounts as its share, being a Mudarib, as agreed between the customer, who is the investment account holder, and the IFI.

Current Accounts
Current accounts are an interest-free loan by the account holder to the Islamic bank, which maintains these funds and pays them to the customer on demand. These accounts are similar to a loan in guarantee and the payment of the same amount. An IFI has the right to invest the funds it is holding in current accounts without the customer bearing any loss. For this reason, the customer does not get any profit on this type of account, but he also does not bear any loss.

Investment Savings Accounts
Many Islamic banks offer savings accounts to their customers. This account allows the account holder to place funds in a safe environment till such time when they may wish to withdraw them. Profits and losses under investment savings accounts accrue on the minimum monthly balance. Profits are paid, or losses are deducted, after the expiry of the financial year and the net profits are determined.

The balances under investment savings accounts are invested on the basis of unrestricted Mudharaba. An Islamic bank has the right to do everything necessary to realize common interest.

An account holder authorizes the Islamic bank to invest the profits made from the moment they are registered in his own account with the Islamic bank.

DIFFERENCES BETWEEN ISLAMIC AND CONVENTIONAL BANKING

There are a number of key differences between the products and services offered by a conventional bank in comparison to an Islamic Financial Institution (IFI). Islamic transactions are created in view of the juristic rules of Islamic Shari’ah and the differences can be highlighted as follows:

     Qur’anic rule: “if the debtor is in a difficulty, grant him time till it is easy for him to repay.” However, if he is procrastinating, the bank applies Shari’ah compliant rules to guarantee its right, but without resorting to interest.

     Funds must be invested in lawful areas that achieve social and economic development. Areas outlawed by Shari’ah must be avoided. The capital is invested on a partnership basis between the bank or entrepreneur and the capital provider.

SHAR’AH ADVISORY BOARDS/COMMITTEES

All Islamic Financial Institutions are required to have a Shari'ah Supervisory Board/Committee. This Board should consist of trustworthy scholars who are highly qualified to issue fatawa (religious rulings) on financial transactions. In addition, Shari'ah board members ought to have considerable experience in modern business/financial dealings and transactions.

The world renown Shari'ah expert, Sheikh Nizam Yaquby points out:

"The Articles of Association, prospectuses, or statutes (depending on the type of activity) should provide for the existence of a Shari’ah advisory board, whose fatawa and resolutions should be binding upon the financial institution's board of directors and management. The advisory board is required to be independent and free to give opinions on proposed contracts and transactions. The role of the Shari’ah supervisory board should be concurrent with that of the financial institution itself in the sense that it should be formed from the moment the financial institution is incorporated, and that it should provide continued supervision and permanent checking of contracts, transactions, and procedures. This should be expressly provided for in the Articles of Association or the prospectus."

ISLAMIC BANKING IN KENYA

The introduction of fully fledged Islamic Banking in Kenya has been eagerly awaited by the Muslim community as the last two years has seen launching of Islamic banking windows by a number of conventional banks. Both the Barclays Bank (Kenya) Limited and Kenya Commercial Bank Limited operate Islamic windows with the former branding its services, "LARIBA Banking".

The entry into the market of both Gulf African Bank and the First Community Bank is expected to usher the first 100% Shari'ah complaint financial institutions with an array of products for their customers. There is currently a lot of expectation from both Muslims and non Muslims for this alternative form of banking that will bring in a new form of partnership and interest free banking. The public has suffered for too long from high interest rates and volatile fluctuation of interest rates by conventional banks.

Current market surveys indicate that a large section of the Muslim community remains untapped by the banking industry due to either non availability of riba-free banking on low incomes. The research also indicates that potential lucrative markets for Islamic banking will be the business community in Nairobi, Mombasa and other towns with sizeable Muslim communities. The challenge will, however, be to convince the Muslim community that these are truly fully fledged Islamic banks with reputable Shari’ah advisory boards of international standards. Both Muslim and non-Muslims look forward to interest-free banking service that is efficient, modern, solid, and transparent and customer friendly. These banks will be require to invest heavily in the latest state of the art technology to reduce costs and remain competitive with conventional banks.

The Central Bank of Kenya and the government has the challenge of opening up the market and changing the Banking Act and Prudential Guidelines to reflect this new reality as has been done in South Africa, Europe, the United States, Canada, the Middle East, Far East and Australia. Kenya has the potential of becoming like Bahrain, the centre of Islamic banking in the region. The Involvement of the Islamic Development Bank, PTA Bank, IFC and Islamic banks and investors in the Middle East is important to turn this into a reality. The regional market is huge as both Muslims and non-Muslims welcome this form of banking that is transparent, and offer caring partnership and free from the uncertainty of interest rate fluctuations.