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Islamic Banking

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Submitted By filyas
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Farhan Ilyas
Islamic banking is banking or banking activity that is consistent with the principles of sharia and its practical application through the development of Islamic economics.
The Basic Difference between Capitalist and Islamic Economy
Islam does not deny the market forces and market economy. Even the profit motive is acceptable to a reasonable extent. Private ownership is not totally negated. Yet, the basic difference between capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions. Their liberty is not controlled by any divine injunctions.

History of Islamic Banking:
Since the beginning of the 18th century, banking has been conducted on an interest-based system of lending money to those in need. With no other alternative available, people had no choice but to borrow money at often high interest rates. This lead to the formation of an unfair system that brought unnecessary hardship on people
It was this need for a fair financial system that brought about the birth of Islamic banking in the mid-1970s. Its objective was to provide a financial alternative that was fair, transparent and above all, a source of economic upliftment for all those in need
Islamic banking, enlightened with the guidance of Islamic Shari‘ah principles, emerged as an alternative financial system that neither gave nor took interest, thereby introducing a fair system of social justice and equality, while fulfilling the financial needs of people and maintaining high standards of ethics, transparency and a sense of responsibility

According to Shari‘ah, interest free loans are meant for cooperative and charitable activities, and not normally for commercial transactions, except in a very limited range. So far as commercial financing is concerned, the Islamic Shari‘ah has a different set-up for that purpose. The principle is that the person extending money to another person must decide whether he wishes to help the opposite party or he wants to share his profits. If he wants to help the borrower, he must rescind from any claim to any additional amount. His principal will be secured and guaranteed, but no return over and above the principal amount is legitimate. But if he is advancing money to share the profits earned by the other party, he can claim a stipulated proportion of profit actually earned by him, and must share his loss also, if he suffers a loss.

It is thus obvious that exclusion of interest from financial activities does not necessarily mean that the financier cannot earn a profit. If financing is meant for a commercial purpose, it can be based on the concept of profit and loss sharing, for which musharakah and mudarabah have been designed since the very inception of the Islamic commercial law
ISLAMIC MOOD OF FINANCE:
Musharakah:
A joint enterprise or partnership structure with profit/loss sharing implications that is used in Islamic finance instead of interest-bearing loans. Musharakah allows each party involved in a business to share in the profits and risks. Instead of charging interest as a creditor, the financier will achieve a return in the form of a portion of the actual profits earned, according to a predetermined ratio.
Example:
Musharakah plays a vital role in financing business operations based on Islamic principles, which prohibit making a profit on interest from loans. For example, suppose that an individual (A) wants to begin a business but has limited funds. Individual (B) has excess funds and wishes to be the financier in musharakah with A. The two people would come to an agreement to the terms and begin a business in which both share a portion of the profits and losses. This negates the need for A to receive a loan from B.

Mudarabah
The term refers to a form of business contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual agreement. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour. The financier is known as ‘rabal-maal’ and the entrepreneur as‘mudarib’. As a financing technique adopted by Islamic banks, it is a contract in which all the capital is provided by the Islamic bank while the business is managed by the other party. The profit is shared in pre-agreed ratios, and loss, if any, unless caused by negligence or violation of terms of the contract by the‘mudarib’ is borne by the Islamic bank. The bank passes on this loss to the depositors.
Murabahah
Most of the Islamic banks and financial institutions are using murabahah as an Islamic mode of financing, and most of their financing operations are based on murabahah. That is why this term has been taken in the economic circles today as a method of banking operations, while the original concept of murabahah is different from this assumption.
“Murabahah” is, in fact, a term of Islamic Fiqh and it refers to a particular kind of sale having nothing to do with financing in its original sense. If a seller agrees with his purchaser to provide him a specific commodity on a certain profit added to his cost, it is called a murabahah transaction. The basic ingredient of murabahah is that the seller discloses the actual cost he has incurred in acquiring the commodity, and then adds some profit thereon. This profit may be in lump sum or may be based on a percentage.
The payment in the case of murabahah may be at spot, and may be on a subsequent date agreed upon by the parties. Therefore, murabahah does not necessarily imply the concept of deferred payment, as generally believed by some people who are not acquainted with the Islamic jurisprudence and who have heard about murabahah only in relation with the banking transactions.

Ijara
Ijara is an exchange transaction in which a known benefit arising from a specified asset is made available in return for a payment, but where ownership of the asset itself is not transferred. The ijara contract is essentially of the same design as an instalment leasing agreement. Where fixed assets are the subject of the lease, such can return to the lessor at the end of the lease period, in which case the lease takes on the features of an operating lease and thus only a part amortisation of the leased asset's value results. In an alternative approach, the lessee can agree at the outset to buy the asset at the end of the lease period in which case the lease takes on the nature of a hire purchase known as ijara wa iqtina (literally, lease and ownership). Some jurists do not permit this latter arrangement on the basis that it represents more or less a guaranteed financial return at the outset to the lessor, in much the same way as a modern interest-based finance lease. The terms of ijara are flexible enough to be applied to the hiring of an employee by an employer in return for a rent that is actually a fixed wage.
Some generally agreed conditions for ijara are as follows : I. The leased item should be transferred to the lessee on completion of the lease agreement and should be of a condition that is fit for performance of the required tasks. The lessor should transfer the leased items to the lessee in their completed form. II. The usufruct of the leased item should have value. III. The amount and timing of the lease payments should be agreed in advance, though the agreed schedule and amount of those payments need not be uniform. IV. The lease payment schedule becomes active upon complete acquisition of the usufruct of the leased goods, whether such usufruct is in fact enjoyed by the lessor or not. V. The period of the lease must be specified. VI. The conditions of usage of the leased items must be stated. VII. The lessor must have full possession and legal ownership of the asset prior to leasing it. VIII. The leased asset must continue to exist throughout the term of the lease. Items which are consumed in the process of usage, ammunition for instance, cannot be leased. IX. In contrast with most conventional finance leases, the responsibility for maintenance and insurance of the leased item under ijara remains that of the lessor throughout. X. A price cannot be pre-determined for the sale of the asset at the expiry of the lease. However, lessor and lessee may agree the continuation of the lease or the sale of the leased asset to the lessee under a new agreement at the end of the initial lease period. XI. In the event of late payment of rental, the ijara may be terminated immediately. XII. The lessor may claim compensation for any damage caused to the leased assets as a result of negligence on the part of the lessee.

Istisna`a
Istisna`a is a contract of exchange with deferred delivery, applied to specified made-to-order items. General agreement upon principles of practice is difficult to identify, however it is often stated that: I. The nature and quality of the item to be delivered must be specified. II. The manufacturer must make a commitment to produce the item as described. III. The delivery date is not fixed. The item is deliverable upon completion by the manufacturer. IV. The contract is irrevocable after the commencement of manufacture except where delivered goods do not meet the contracted terms. V. Payment can be made in one lump sum or in instalments, and at any time up to or after the time of delivery. VI. The manufacturer is responsible for the sourcing of inputs to the production process.
Istisna`a differs from ijara in that the manufacturer must procure his own raw materials. Otherwise the contract would amount to a hiring of the seller's wage labour as occurs under ijara.
Istisna`a also differs from bay salam in that * the subject matter of the contract is always a made-to-order item, * the delivery date need not be fixed in advance, * full advance payment is not required and * The istisna`a contract can be canceled but only before the seller commences manufacture of the agreed item(s).
Bay al-salam
Bay al-salam is a contract for deferred delivery that was originally sanctioned during the time of the Prophet, peace be upon him, to facilitate the trading activities of farmers who were awaiting the harvest of crops. In more modern times it has also been applied to the production of raw materials and fungible goods in general.
Generally agreed conditions for bay al-salam are that: I. The goods sold need not be in existence at the time of contracting. II. The delivery date and location must be specified. III. Full advance settlement of the agreed trade price is required at the time of contracting, otherwise the contract would sanction the trading of one debt for another which is not deemed permissible in Islam. IV. The quality of the items to be delivered should be defined. Items must be fungible in nature. Hence, rare items, or those that are not precisely specifiable, cannot be the subject of the bay al-Salam contract. If the quality of the items upon delivery are found to be other than specified, the buyer has the right of refusal. V. The quantity of the items to be delivered should be defined and fixed according to the normal method of measurement of those items and should not depend upon unforeseeable factors. The quantity of goods purchased under the bay al-salam contract cannot for example be defined as that resulting from the cultivation of a given plot of land since such a quantity may vary according to unforeseeable factors. VI. The buyer does not enjoy ownership of the goods until delivery has taken place. VII. The buyer has the right to take surety from the seller as a form of performance bond. VIII. Where the seller is unable to produce the contracted items on the delivery date, the buyer may nullify the bay al salam contract and exercise the performance bond. IX. The seller may deliver the contracted items irrespective of the buyer's circumstances on the delivery date.

Islamic financing is clearly distinguishable from the interest-based financing on the following grounds. 1. In conventional financing, the financier gives money to his client as an interest-bearing loan, after which he has no concern as to how the money is used by the client. In the case of murabahah, on the contrary, no money is advanced by the financier. Instead, the financier himself purchases the commodity required by the client. Since this transaction cannot be completed unless the client assures the financier that he wishes to purchase a commodity, therefore, murabahah is not possible at all, unless the financier creates inventory. In this manner, financing is always backed by assets. 2. In the conventional financing system, loans may be advanced for any profitable purpose. A gambling casino can borrow money from a bank to develop its gambling business. A pornographic magazine or a company making nude films are as good customers of a conventional bank as a house-builder. Thus, conventional financing is not bound by any divine or religious restrictions. But the Islamic banks and financial institutions cannot remain indifferent about the nature of the activity for which the facility is required. They cannot effect murabahah for any purpose which is either prohibited in Shari‘ah or is harmful to the moral health of the society. 3. It is one of the basic requirements for the validity of murabahah that the commodity is purchased by the financier which means that he assumes the risk of the commodity before selling it to the customer. The profit claimed by the financier is the reward of the risk he assumes. No such risk is assumed in an interest-based loan. 4. In an interest bearing loan, the amount to be repaid by the borrower keeps on increasing with the passage of time. In murabahah, on the other hand, a selling price once agreed becomes and remains fixed. As a result, even if the purchaser (client of the Bank) does not pay on time, the seller (Bank) cannot ask for a higher price, due to delay in settlement of dues. This is because in Shari‘ah, there is no concept of time due of money. 5. In leasing too, financing is offered through providing an asset having usufruct. The risk of the leased property is assumed by the lessor / financier throughout the lease period in the sense that if the leased asset is totally destroyed without any misuse or negligence on the part of the lessee, it is the financier/lessor who will suffer the loss.

ADVANTAGES OF ISLAMIC BANKING
Some of the major advantages of Islamic banking: 1. Justice and Fairness: The main feature of the Islamic model is that it is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. This system of financial intermediation will contribute to a more equitable distribution of income and wealth. 2. Liquidity: Follow the profit and loss-sharing principle to mobilise resources and are less likely to face any sudden run on deposits. As such, they have a minimum need for maintaining high liquidity 3. Better Customer Relations: Financing and deposits are extended under the profit and loss sharing arrangement. The banks are likely to know their fund users better in order to ensure that the funds are used for productive purposes and vice-versa for investors. In this way, it develops better relations between the financial intermediary and the fund providers or consumers. It will also promote productive economic activities and socio-economic justice. 4. No Fixed Obligations: Islamic banks do not have fixed obligations such as interest payments on deposits. Therefore, they are able to allocate resources to profitable and economically desirable activities. This also holds good for Islamic financing, as the payment obligations of the entrepreneur is associated with the revenue. 5. Transparency: Transparent to the account holders on the investments made in different areas and the profits realized from these investments. The profit is then shared in the pre-agreed ratio

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Bba in Islamic Banking

...1.0 INTRODUCTION In Malaysia, there are numerous financial instruments and concepts available for customers to choose, which one is suited to them. Financial instruments that available in Islamic Banks in Malaysia are divided into two main components which are known as deposit; and loans and advances. Bay’Bithaman Ajil (BBA) and Murabahah are 2 types of Islamic financing product offered by banks in Malaysia and were introduced in 1983. The Islamic financing product of Murabahah was introduced to meet the above Quranic verse interpretation. It should be noted that BBA is a Murabahah product but the product name of BBA was given by BBMB to differentiate between a short term (below 12 months) and long-term (above 12 months) tenor financing products. Murabahah is for short term meanwhile BBA is for a long term financing products. 2.0 BAI’ BITHAMAN AJIL (BBA) 2.1 DEFINITION The Majallah refers to BBA as the Bai’ al Muajjal. In Pakistan the term is called Bai’ al-Muajjal, in Bangladesh it called bay’al-Muazaal. BBA means a "deferred payment sale". It is a sale contract in which the payment of the price is deferred and payable at a certain particular time in the future. It is a mode of Islamic financing used for property, vehicle, as well as financing of other consumer goods. It can be implicated in any sale contract, including Musawamah and Murabahah but it is not applicable for a Salam contract, as the payment of Salam must be settled in full at the beginning of the......

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