Wednesday, 21 April 2010

Why Islamic Banking?


Recently, I have encountered a few brothers discussing about Islamic banking and some don't really understand what Islamic banking is all about and they're having doubts about it. The doubts are to the extent where one brother believes Islamic banking is created to manipulate the people and create a new market. In this entry I will try and explain the historical evolution of Islamic banking to the extent of knowledge given to me.

Generally Islamic banking accepts almost all kind of transactions except any transactions that deals with riba(interest) and gharar(uncertainty). Why doesn't it accept riba(interest) and gharar(uncertainty)? The law is being extracted from the Holy Qur'an and the Sunnah/Hadith.

"Those who devour interest, they behave as the one whom Satan has confounded with his touch seized in the state they say : " Buying and selling is but a kind of interest," even though Allah has made buying and selling lawful and interest unlawful. Hence he who receives this admonition from his Lord, and then gives up (dealing in interest), may keep his previous gains, and it will be for Allah to judge him. As for those who revert to it, they are the people of Fire and in it shall they abide." ( Surah al-Baqarah verse 275)

"Allah will deprive usury of all blessing, but will give increase for deeds of charity: For he loveth not creatures ungrateful and wicked." (Surah al-Baqarah verse 276)

"Truly the reward of those who believe and do righteous deeds and establish Prayer and pay Zakah is with their Lord; they have no reason to entertain any fear or grief." (Surah al-Baqarah verse 277)

"O ye who believe! Fear Allah, and give up what all outstanding interest, if ye are indeed believers." (Surah al-Baqarah verse 278)

"If the debtor is in a difficulty, grant him time Till it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew." (Surah al-Baqarah verse 280)

"O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really ) prosper." (Surah al-Imran verse 130)

"That they took usury, through they were forbidden; and that they devoured men's substance wrongfully; we have prepared for those among them who reject faith a grevious punishment." (Surah al-Nisa verse 161)

"Whatever you pay as interest so that it may increase the wealth of people does not increase in the sight of Allah. As for Zakah that you give, seeking with it Allah's good pleasure, that is multiplied manifold. (Surah al-Rum verse 39)

The sequence of these revelation on riba thath came to our Prophet Muhammad Salallahu Alaihi Wassallam starts with the verse from Surah al-Rum, al-Nisa, al-Imran and al-Baqarah. Riba is understood by the Prophet Salallah Alaihi Wassallam and has taught us certain ways to avoid it through his sunnah ad hadith. Evolution has forced a lot of changes hence, riba also evolves. The important thing is that we have to understand riba and gharar and it is not something that people have created in recent times. The question here is, is it being conducted or practiced correctly?

Here are some verses from the bible on interest.

"If one of your countrymen becomes poor and is unable to support himself among you, help him as you would an alern or a temporary resident, so he can continue live among you. (36) Do not take interest of any kind from him, but fear your God, so that your countryman may continue to live among you. (37) You must not lend him money at interest or sell him food at a profit." (Leviticus 25:35-37)

(19)"Thou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of any thing that is lent upon usury." (Deuteronomy 23:19)

"If thou lend money to any of my people that is poor by thee, thou shalt not be to him as and usurer, neither shalt thou lay upon him usury." (Exodus 22:25)

(35)"But love ye your enemies, and do good, and lend, hoping for nothing in return; and your reward shall be great, and ye shall be the children of the Highest: for he is kind unto the unthankful and to the evil." (Luke 6:35)

The followers of the bible have then understood these verses of prohibition on interest as; if a person is being oppressed of poor. They argue that it is permissible to charge interest to the rich or capable. John Calvin a precher in the 1500s claim that there is no problem on the interest as long as it doesn't bother the poor. I'm not going to through this in detail here.

So, conventional banking has no boundaries for it to be developed or evolve where else, Islamic banking has to be cautious on the development so that the prohibited will be avoided. Colonisation had an incredibly detriment affect on Islamic countries as noted by AbdelKader Chachi (2005). This occurred through disruption to the Islamic societies, which inevitably lead to Muslims being pushed away from the initial teachings of Islam. Subsequently, this leads to the stagnation in Islamic politics and economics, hindering the evolution of Islamic banking.

The recent Islamic banking industry is actually a mixture of conventional banking and the theoratical practices of Prohphet Muhammad within the constraints of permissible action which evade the prohibitions of interest and etc. For this reason, Islamic banking is always bound to have misconduct practices.

I am going to express my thought in interest. If one were to calculate for example £1 is borrowed at 5% interest in 1000 years, the new total would be £1,546,318,920,731,950,000,000. Look at the big difference! Logically no one would make a loan for 1000 years but a person would apply for a loan for thousands or millions of £ in a shorter time length. So my question is, is it fair to be paying and earning interest? Obviously, everyone is entitled to their opinion but my personal opinion is a definite NO. This is unfair because one can earn money without even doing anything.

Let us make a situation where one wants to buy a car. One buys a car through conventional banking and the car cost £5000. The person applies for a loan from the conventional banking to buy the car. The bank agrees to approve the loan of £5000and expect a repayment of £5000 plus the interest. Let's say the total of repayment after 3 years is £7000.

The same situation but in Islamic banking. The person applies for a bank to buy the car for him and he will settle the payment with the bank in deferred payments. The bank agrees to buy the car for £5000 and sell it to the person for £7000 and the settlement is after 3 years. This transaction is called Murabaha, where the cost of the product and the profit margin is known to the client. Both have the same amount, so what is the difference?

In conventional banking, if a person misses a payment there is a recalculation of interest. The bank loans out the money to earn more money.

In Islamic banking, if the person miesses a payment, the same amount of payment still have to be carried out but the client may be charged a penalty and this penalty should not go to the bank but to a charity(this is a lengthy topic so I'm going to cut short). The bank actually buys the car from the supplier and delivers it to the client. In other words, the bank is conducting a trading. So the bank actually holds the risk where the bank has to deliver the car to the client and is responsible if anything happens to the car before it reaches the client, therefore the bank is entitled to earn some profit from the trading. There is a Hadith which says " Al kharaj bi al-dhaman" which means "no risk, no gain/reward/income/profit". Even though both look similar, but it is actually different. But do Islamic banks really conduct in this manner remain quesntionable. I hope this entry has given some exposure to everyone.


  1. Good article..

  2. A really good and concise article about Islamic banking. You've taken something that is very complex to some people and described it in layman's term. Which is very beneficial to people like myself who would like to know more about Islamic banking yet struggle to understand the terms and jargons.

    Before this article I never really understood how Islamic banking is different to conventional banking. I always thought there was a really big difference between the two. However, after reading this, was rather surprise to read how almost similar it is, yet different, if you know what I mean?

    Your example of a person buying a vehicle was really good. I didn't realise that you can still make the same profit trading in Islamic banking than conventional banking. Although the car you used actually cost £350,000 and not £5000 :-)

    In a nutshell, really really interesting. Well done. I'm sure there are more to the explanation of Islamic banking but for now I think I know a little bit more than I know before which is good. Bring on the next article. This time, you don't have to put a car to grab my attention, your writing is good enough!


  3. @3dz, this is the response to the article that you gave me