Islamic Banking

Islamic banking is banking or financing activity that complies with sharia (Islamic law) and its practical application through the development of Islamic economics. Some of the modes of Islamic banking/finance include Mudarabah (Profit and loss sharing), Wadiah (safekeeping), Musharaka (joint venture), Murabahah(cost plus), and Ijar (leasing). Sharia prohibits riba, or usury, defined as interest paid on all loans of money (although some Muslims dispute whether there is a consensus that interest is equivalent to riba). Investment in businesses that provide goods or services considered contrary to Islamic principles  is also haraam.

These prohibitions have been applied historically in varying degrees in Muslim countries/communities to prevent un-Islamic practices. In the late 20th century, as part of the revival of Islamic identity, a number of Islamic banks formed to apply these principles toprivate or semi-private commercial institutions within the Muslim community. Their number and size has grown so that by 2009, there were over 300 banks and 250 mutual funds around the world complying with Islamic principles, and around $2 trillion were sharia-compliant by 2014. Sharia-compliant financial institutions represented approximately 1% of total world assets, concentrated in the Gulf Cooperation Council (GCC) countries, Iran, and Malaysia. Although Islamic Banking still makes up only a fraction of the banking assets of Muslims, since its inception it has been growing faster than banking assets as a whole, and is projected to continue to do so.

The industry has been lauded for returning to the path of “divine guidance” in rejecting the “political and economic dominance” of the West, and noted as the “most visible mark” of Islamic revivalism. Its most enthusiastic advocates promising “no inflation, no unemployment, no exploitation and no poverty” once it is fully implemented.  But it has also been criticized for failing to develop profit and loss sharing or more ethical modes of investment promised by early promoters, and instead selling banking products that “comply with the formal requirements of Islamic law”, but use “ruses and subterfuges to conceal interest”, and entail “higher costs, bigger risks” than conventional (ribawi) banks.

Money on the most common type of Islamic financing — debt-based contracts — “must be made from a tangible asset that one owns and thus has the right to sell — and in financial transactions it demands that risk be shared.” Money cannot be made from money. Another statement of the Islamic banking theory of finance is: “Money has no intrinsic utility; it is only a medium of exchange.” Other restrictions include

  • Islamic banks are to collect zakat (obligatory religious alms giving) from customers’ accounts — at least according to some sources.
  • A board of Shariah experts is to supervise and advise each Islamic bank on the propriety of transactions to “ensure that all activities are in line with Islamic principles”. 
  • Risk sharing. symmetrical risk and return on distribution to participants so that no one benefits disproportionately from the transaction.

In general, Islamic banking and finance has been described as having the “same purpose” as conventional banking but operating in accordance with the rules of shariah law (Institute of Islamic Banking and Insurance), or having the same “basic objective” as other private entities, i.e. “maximization of shareholder wealth” (Mohamed Warsame). In a similar vein, Mahmoud El-Gamal states that Islamic finance “is not constructively built from classical jurisprudence”. It follows conventional banking and deviates from it “only insofar as some conventional practices are deemed forbidden under Sharia.”