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This paper reviews the progress of Islamic banking from both theoretical and practical It highlights the basic principles on which Islamic banking is based and. The World Bank Global Islamic Finance Development Center - German banking regulator hosted an Islamic finance conference. Nearly 20 percent annual growth of Islamic finance in recent Keywords: Islamic Finance, Islamic Banking, Monetary Policy, Financial Stability.
But whoever returns to [dealing in interest or usury] - those are the companions of the Fire; they will abide eternally therein.
Arbun Arbun is a deposit of a downloader, which is payable to the seller after approval of the sales contract, which is not refundable. The down payment serves as a security so that the download contract is fulfilled at the specified time. Bai Salam In the case of the form of contract of Bai Salam, payment is made in cash, but the goods will be delivered at a later date.
It is important to describe the ordered goods precisely in quantity and quality. The exact delivery date and the delivery location must also be recorded. This form of contract was introduced mainly for farmers who were able to grow products and feed their families before harvesting. Gharar The term "Gharar" means uncertainty or risk under a contract and it has an important meaning in regards to derivative transactions.
The prohibition of excessive speculation is one of the pillars of Islamic banking. In order to minimize the risk of Gharar, contracts must be defined precisely for both contracting parties. Moreover, the contract must not be linked to an uncertain event, in which one does not know beforehand whether it occurs or not.
Therefore a lack of transparency and incompleteness are a sign of Gharar. On the other hand, the Islamic law schools recognize that successful economic activity is associated with corresponding economic risks.
However, the short-term download and sale of shares with the aim of realizing short-term price gains is not permitted according to a broad scholarly opinion Ijarah Ijara is the renting or leasing of a property. The bank allows its customers to use a certain asset. The bank remains to be the owner until the end of the contract and, depending on the form of the contract, she receives a fixed leasing rate or a share of the profit generated from the use of the asset.
Istisna The term Istisna refers to an industry supply contract.
In the context of Islamic banking, the term Istisna refers to the financing of non-finished items. According to Islamic law, only existing goods can be acquired. In the case of an Istisna financing, a contract is concluded in which the project or the item is described in detail.
Payment may be made either at the end of the term or in installments. These are strictly forbidden in Islam. In addition, contracts which constitute a bet between the issuer and the downloader or investor are prohibited because they ultimately generate a winner and a loser and are economically unproductive.
Under Islamic law, only goods which already exist and are the property of the seller may be sold. Derivative transactions are therefore only permitted if they are used to hedge a transaction and short-term sales are particularly prohibited.
Likewise, conventional insurance is not permitted because it could be considered a bet between insurer and policyholder on the occurrence of a claim or about the death of the policyholder. Mudaraba In the Mudarabah model the bank is a shareholder in a project of the customer. The bank invests as an asset manager the deposits in Sharia-compliant enterprises, whereby with the economic success of the enterprise the bank and the investor receive a previously fixed share of the generated income of the enterprise in addition to the complete repayment.
The customer is solely responsible for the entire business and the bank has no influence on the management. The distribution in case of profitmaking must be defined at the beginning.
In the event of loss, only the investor - in this case the bank - bears the risk. Mudarabah is therefore financed in the form of a silent partnership. These accounts can lead to losses for the investor, but Islamic banks usually invest these funds very cautiously. Both parties to the contract are liable for the company and for the risks according to their capital shares. The individual investor is then involved in the average return on all such credit transactions.
The bank acts as intermediary. Here, as in the 'western' banking system, there are savings and long-term investments. However, the customer does not receive fixed interest rates for his deposits, but deposits are also subject to profit distribution, depending on the specific design. At the start of the contract, a key is defined according to which the returns from the bank's credit portfolio are distributed between the bank and the customer after deduction of the fixed product costs.
Regarding the allocation of funds in Islamic banking the Murabaha — due to being close to being an external financing - has the most important relevance.
The Ethics Council is a religious supervisory board, which is responsible for monitoring the Islamic conformity of the products. Sukuk Sukuk are Islamic securities where no interest is paid on the invested capital.
Instead of an interest payment, investors receive income from investments. It can be compared in a simplified way with a covered bond or with a profit participation certificate.
Each Sukuk is based on the securitized ownership of real assets. The volume of the issue is limited to the value of such assets.
According to his share, the downloader of the Sukuk receives a percentage of the often variable income from the utilization of the assets. In the case of real estate, for example, the customer receives his share in the form of proportionate rental income. Here, too, the investor does not receive a fixed interest rate.
By investing in real-world values, Sukuks are less vulnerable to a separation of the market from the real economy. Takaful The term Takaful refers to an Islamic insurance that works similar like a cooperative. Conventional insurances are largely rejected by Islamic jurists because, in strict interpretation, they violate the prohibition of 'maysir' as in gambling: there is a winner and a loser. In addition, the financial investment of life insurers in particular violates the interest ban.
A Sharia-compliant form of insurance is 'Takaful', the mutual guarantee. A community of insured parties does not only share the risks, they also share the company's profit assurance of reciprocity. It is similar in principle to the German insurance association on reciprocity. At the Takaful, all policyholders are simultaneously co-owners of the pool of deposits from which the insurance services are paid.
If the benefit payments exceed the pool holdings, the insurance company prepays the deficit without interest. Sarf, 21 Bay al-Sarf is a contract of exchange of money for money. This contract is tightly regulated under Sharia because it can be easily manipulated for the purpose of producing an interest- bearing loan, which is prohibited in Islam.
Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, match for match, hand to hand.
Whoever wants more or more, has already run an interest business. The beneficiary and the debtor are in debt the same. Because both counter values must be settled immediately, a forward transaction in which one of the counter values is delivered at a future date is not allowed.
Other scholars argue that if the monetary system were correctly designed, then money would comprise gold and silver throughout the world i.
American money would be made of gold, Malaysian money would be made of gold, etc. Here, the arguments over the Sharia position on modern foreign exchange and currency trading are seen to arise because these markets are of themselves built upon un-Islamic foundations. Pros and Cons Islamic Banking From a customer perspective many approaches of Islamic banking are theoretically positive based on the principles of overall social benefit and the possibility of a genuine partnership between customer and the banking provider.
Because of the relative youth of Islamic banking in our times, it will be necessary to see to which extend transparency prevails and whether commandments of the Quran against outsmarting clients are circumvented with the individual products or not due to the many different Islamic jurisdictions and denominations as well.
In the global market of Islamic banking products, there will be certainly examples for both. Because deposits an economic comparability with traditional Western deposits is only partially possible as it can only be conducted in retrospect, the returns on the Islamic deposits are variable in principle and they are also influenced by other factors than the known ones from conventional Western banking.
This ensures that economic savings are channeled into the real economic sector. KT Bank invests the funds of its investors in industry and trade while sharing the success of the customers.
Islamic banking is thus a part of the SRI Socially Responsible Investment sector and it stands for sustainable, integrated and responsible investment.
Fundamental principles, such as consistent risk management or good corporate governance, apply to both the Islamic and the Western financial systems and help ensure a secure and viable international banking system. As a contemporary Islamic bank, KT Bank is open to all customers who are looking for a socially responsible and sustainable financial service provider - regardless of nationality or religious affiliation.
However, the Islamic KT bank in Germany has been admitted as a member of the compensation institution of German banks. The deposits are therefore secured up to EUR , per person At the same time this coverage constitutes a theoretical deviation from Islamic banking, which obviously emphasizes the possibility of a loss as much as of a profit.
An insurance against loss simply reeks of Maysir. Special offers to Turkish-speaking consumers in Germany are, for example, in the same vein as they do not automatically mean Islam compliant offers just because they are presented in the language of the biggest Muslim group in the country. The basic principle of the Islamic insurance, the Takaful, might be quite useful from the point of view of the customer due to the absence of casino capitalist investments into derivatives at the stock market.
However, particularities for the participation in surpluses and the financing of losses must be closely examined. The administration of Takaful policies is relatively complex, which could make them more expensive than traditional policies.
The fund-linked pension insurance schemes offered by conventional insurers could no longer be considered Sharia- compliant as they are mainly interest-based.
In the eyes of a Western financial professional these Islamic guidelines increase the risk of the investor, particularly in the case of long-term investments which correspond in all respects to the principles of Islamic criteria.
There are no pre-payments in the form of interest and one may have to wait five or ten years for a profit to be made and one does not know whether said profit is high enough relative to the investment or not.
Islamic banking and finance
Accordingly, short-term investments are probably preferred. The assumption is that the motivation is not different from the traditional Western banking system in "Islamic Banking": one is looking for an acceptable investment with the greatest possible risk avoidance.
These questions have let Swiss banks to even cut back on Islamic banking: Stefan Leins 25, Ethnologist and Specialist for Islamic Banking, sees two reasons why Swiss Banks are not counting in Sharia-compliant financial products anymore. There are a number of Islamic financial instruments mentioned in the Financial Management syllabus and which can provide Shariah-compliant finance: Murabaha is a form of trade credit for asset acquisition that avoids the payment of interest.
Instead, the bank downloads the item and then sells it on to the customer on a deferred basis at a price that includes an agreed mark-up for profit. The mark-up is fixed in advance and cannot be increased, even if the client does not take the goods within the time agreed in the contract. Payment can be made by instalments.
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The bank is thus exposed to business risk because if its customer does not take the goods, no increase in the mark- up is allowed and the goods, belonging to the bank, might fall in value. Ijara is a lease finance agreement whereby the bank downloads an item for a customer and then leases it back over a specific period at an agreed amount. Ownership of the asset remains with the lessor bank, which will seek to recover the capital cost of the equipment plus a profit margin out of the rentals payable.
Emirates Airlines regularly uses Ijara to finance its expansion. Another example of the Ijara structure is seen in Islamic mortgages. The customer makes regular payments to cover the rental for occupying or otherwise using the property, insurance premiums to safeguard the property, and also amounts to pay back the sum borrowed.
At the end of the mortgage, title to the property can be transferred to the customer. The demand for Islamic mortgages in the UK has shown considerable growth.
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Mudaraba is essentially like equity finance in which the bank and the customer share any profits. The bank will provide the capital, and the borrower, using their expertise and knowledge, will invest the capital. Profits will be shared according to the finance agreement, but as with equity finance there is no certainty that there will ever be any profits, nor is there certainty that the capital will ever be recovered.
This exposes the bank to considerable investment risk. In practice, most Islamic banks use this is as a form of investment product on the liability side of their statement of financial position, whereby the investor or customer as provider of capital deposits funds with the bank, and it is the bank that acts as an investment manager managing the funds. Musharaka is a joint venture or investment partnership between two parties.
Both parties provide capital towards the financing of projects and both parties share the profits in agreed proportions. This allows both parties to be rewarded for their supply of capital and managerial skills. Losses would normally be shared on the basis of the equity originally contributed to the venture. Sukuk is debt finance.
A conventional, non-Islamic loan note is a simple debt, and the debt holder's return for providing capital to the bond issuer takes the form of interest.
Islamic bonds, or sukuk, cannot bear interest.
So that the sukuk are Shariah-compliant, the sukuk holders must have a proprietary interest in the assets which are being financed. Asset-based is obviously more risky than asset backed in the event of a default.
There are a number of ways of structuring sukuk, the most common of which are partnership Musharaka or lease Ijara structures.
Typically, an issuer of the sukuk would acquire property and the property will generally be leased to tenants to generate income. The sukuk, or certificates, are issued by the issuer to the sukuk holders, who thereby acquire a proprietary interest in the assets of the issuer. The issuer collects the income and distributes it to the sukuk holders. This entitlement to a share of the income generated by the assets can make the arrangement Shariah compliant. The cash flows under some of the approaches described above might be the same as they would have been for the standard western practice paying of interest on loan finance.
A Primer on Islamic Finance
However, the key difference is that the rate of return is based on the asset transaction and not based on interest on money loaned. The difference is in the approach and not necessarily on the financial impact. In Islamic finance the intention is to avoid injustice, asymmetric risk and moral hazard where the party who causes a problem does not suffer its consequences , and unfair enrichment at the expense of another party.
Advocates of Islamic finance claim that it avoided much of the recent financial turmoil because of its prohibitions on speculation and uncertainty, and its emphasis on risk sharing and justice.
That does not mean, of course, that the system is free from all risk nothing is , but if you are more exposed to a risk you are likely to behave more prudently.
The Shariah board The Shariah board is a key part of an Islamic financial institution.Islamic finance rests on the application of Islamic law, or Shariah, whose primary sources are the Qur'an and the sayings and practice of the Prophet Muhammad.
The Ihlas Finance House in Turkey closed in due to "liquidity problems and financial distress". The Egypt-Jordan Bank [a conventional bank] made me wait so long. Customers evaluate which bank fits those highly fluid and competing priorities better. This is because if credit was provided by taking "a direct equity stake in every enterprise" the PLS approach it would contract in a credit crunch.
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