* 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 their way into the constitutions of Arabic countries like Kuwait. Today Islamic jurisprudence is a code of conduct that on the one hand regulates the relationship between Allah and the mankind [arab. ʿibādāt] and on the other hand the economic and interpersonal relationship between individuals [arab. mu’amāt].
Since the entire legal framework of Islamic banking is codified in the Sharīʿah, every Islamic bank in the GCC region and the majority of the remaining Islamic banks worldwide have an in-house Sharīʿah -board that audits the compatibility of the banks’ products and services with the restrictions imposed by the Islamic law. In the following, the main principles of Islamic banking are explained. * Prohibition of riba, gharar and maysir
(Qur’an 4:161)
The first and most important feature of Islamic Finance and moreover of Islamic commercial law is the prohibition of riba [arab. ribā]. Literally translated, it means “addition” or “process” of growth, whereas the technical meaning of riba is the charging and receiving of any kind of interest. The rationale is that a financial system involving interest leads to an unjust distribution of income in society. The Qur’an does not give a clear definition of riba, but as outlined in the quote above, the usurious character of deviating money from lending and borrowing goods or money is stressed in four different verses in the Qur’an. 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 e.g. in terms of derivatives trade is meant to support the efficiency on liquidity markets. Nevertheless it is strictly prohibited under Islamic law. The same is valid for the futures market, because physical delivery of goods does not take place. With the prohibition of maysir, the Sharīʿah forbids gambling and games of chance. * Focus on halal activities
In addition to the fundamental prohibitions and the subsequent limitations for banking activity, one general rule that is prescribed for all activities in life of a muslim and therefore also for Islamic banks is the prohibition of committing haram activities, but instead seeking for halal [engl. permissible] labour. Everything that is forbidden in Islamic law is meant to be haram; the ignorance of this general rule is a sin. For Islamic banks haram activities are investments in industries related to defence, gambling, and pornography. Further the production or use of alcohol as well as the production and consumption of pork products shall not be promoted. Everything that is not haram, is accepted or rewarded by Allah. An example for extraordinary halal activity is zakat (almsgiving), imposed on the income of banks. The defining difference between Islamic and conventional finance is that Islamic finance is guided by religious goal in addition to the purpose of profit maximization within a legal framework. Still, the deviating opinions of the Sharīʿah-boards lead to the fact that some Islamic banks may offer products that others ban.
Bibloography:

Habib, Ahmed: Money and Exchange Rate in an Islamic Economy, Finance in Islam, URL: http://www.financeinislam.com/printer_friendly/1_36/174, (03.08.2010)

Iqbal, M, (2006): A broader definition of riba: Pakistan Institute of Development Economics (PIDE), working paper
Khan, Mohammad Akram(1988): Commodity Exchange and Stock Exchange trading in Islamic Economy, American Journal of Islamic Social Science, Vol.5, Nr.1
Glassner M., Wackerbeck P. (2007): Islamic Finance, Bank Verlag Medien, p.154

Khan, Mohammad Akram(1988): Commodity Exchange and Stock Exchange trading in Islamic Economy, American Journal of Islamic Social Science, Vol.5, Nr.1, p.97

Mahmod El Gamal (1999): An Economic Explication of the Prohibition of Gharar In Classical Islamic Jurisprudence, Univ. of Rice, Houston, USA

Pickthall M.,URL: www.qurantoday.com,(02.08.2010)

URL: www.thefreedictionary.com/Quran (28.08.2010)
URL: http://islam.about.com/od/law/g/fatwa.htm ( 17.08.2010)

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[ 1 ]. “The sacred writings of Islam revealed by Allah to the Prophet Mohammad during his life at Mecca and Medina.” URL: www.thefreedictionary.com/Quran (28.08.2010)
[ 2 ]. The way of life prescribed as normative in Islam, based on the teachings and practices of Prophet Mohammad and exegesis of the Qur’an, also called hadith
[ 3 ]. There are four schools of law or ‘Madhahibs’: Shafi’i, Maliki, Hanafi, and Hanbali school. Hanbali school, dominant in the GCC defines the industry, since most Islamic finance is funded in this region.
[ 4 ]. “That they took usury, though they were forbidden; and that they devoured men's wealth wrongfully. We have prepared for those among them who reject Faith a grievous chastisement.” Translation of the Qur’an by the Presidency of Islamic Researchers
[ 5 ]. Iqbal, M, (2006): A broader definition of riba: Pakistan Institute of Development Economics (PIDE), working paper
[ 6 ]. “A fatwa is an Islamic religious ruling, a scholarly opinion on a matter of Islamic law. It is issued by a recognized religious authority in Islam. But since there is no hierarchical priesthood or anything of the sort in Islam, a fatwa is not necessarily "binding" on the faithful.” URL: http://islam.about.com/od/law/g/fatwa.htm ( 17.08.2010)
[ 7 ]. Habib, Ahmed: Money and Exchange Rate in an Islamic Economy, Finance in Islam, URL: http://www.financeinislam.com/printer_friendly/1_36/174, (03.08.2010)
[ 8 ]. Mahmod El Gamal (1999): An Economic Explication of the Prohibition of Gharar In Classical Islamic Jurisprudence, Univ. of Rice, Houston, USA
[ 9 ]. The Encyclopaedia of Islamic Jurisprudence
[ 10 ]. Exceptions are made in cases of common law, e.g. house building with Bay Salam contracts
[ 11 ]. Khan, Mohammad Akram(1988): Commodity Exchange and Stock Exchange trading in Islamic Economy, American Journal of Islamic Social Science, Vol.5, Nr.1
[ 12 ]. However, in March 2010, the International Swaps and Derivatives Association (ISDA) launched a “(Tahawuut) Hedging Master Agreement” together with the International Islamic Financial market (IIFM). The agreement provides the structure under which Islamic financial institutions can transact derivatives trade such as currency swaps.
[ 13 ]. Glassner M., Wackerbeck P. (2007): Islamic Finance, Bank Verlag Medien, p.154
[ 14 ]. Khan, Mohammad Akram(1988): Commodity Exchange and Stock Exchange trading in Islamic Economy, American Journal of Islamic Social Science, Vol.5, Nr.1, p.97
[ 15 ]. “They question thee about strong drink and games of chance. Say: In both is great sin and some utility for men. But the sin is greater than their usefulness”. Qur’an, verse 2:219, translation: Pickthall M.,URL: www.qurantoday.com,(02.08.2010)