Why Islamic Banking (BUSINESS RECORDER)Sept.1,2004
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by Dr. Rukhsar Ahmed

Islamic banking has emerged as a new reality in the international financial scene. Its philosophies and principles are however, not new, having been outlined in the Holy Qur'an and the Sunnah (words, action and approval of the Prophet where later put in writing by his followers and transmitted to others as "hadith") of Prophet Muhammad (p.b.u.h.) more than 1,400 years ago. The emergence of Islamic banking is often related to the revival of Islamic financial system which is totally usury (riba) free. Riba literally means increase, addition, expansion or growth which are non-trade related e.g. a loan, advances. Technically however, there is no specific or precise definition of "riba" thus excessive profits under certain condition, is also said, may tantamount to Riba.

Islamic Banking in the modern world

Islamic Banking in the modern world, generally aims to promote and develop the application of Islamic principles, law and traditions to transactions of financial, banking and related business affairs. It is also to promote investment companies to be engaged in such business activities that are acceptable and consistent within the Shariah precept. Islamic banks, by doing so, will safeguard the Islamic communities and societies from activities that are forbidden in Islam.


Justice is such an indispensable ingredient of the Islamic faith that it is impossible to perceive the ideal Muslim society where justice has not been established. Islam wishes to eradicate from human society all traces of zulm, a comprehensive Islamic term referring to all forms of inequity injustice, exploitation, oppression and wrongdoing whereby a person either deprives offers of their rights or does not fulfill his obligations towards them.

As emphasis in earlier definition of Islamic banking system, Islamic Banks doe not deal with loans (except for benevolent loan - Qardh Hassan). Instead, they introduce Musharakah (Partnership), Al-Bai Bithaman Ajil (deferred payment sale as a result from trading activity) and Mudharabah (Profit Sharing of gain and losses), which make the investments of the Islamic Banks depend on the usefulness and feasibility to the project in which the money is invested.

This is a contrast with traditional banks using the conventional system that loans out money for interest, without regard as to the usage to which the money will be put, because the bank knows that the client is able to repay the loan.





Goals of Islamic Banking

The Banking system should, like all other aspects of the Islamic way of life, be made to contribute richly to the achievement of the major socio-economic goals of Islam. The system should also continue to perform the usual functions that relate to its own special field which other banking systems performs.

Some of the most important goals and function necessary for an Islamic Banking system are socio-economic justice and equitable distribution of income and wealth as well as the stability in the value of money to enable the medium of exchange to be a reliable unit of account.

Mobilization and investment of savings, coupled with effective rendering of all services normally expected from the banking system are equally important in achieving the goals of an Islamic banking services provider.

It may be argued that the goals and functions of the Islamic banking system are similar to those under capitalism but there is in fact a significant difference in emphasis, arising from the divergence in the commitment of the two systems to spiritual values, socio-economic justice and human brotherhood.

The main principles of Islamic banking are the prohibitions of interest (usury) in all transactions, the undertaking business and trade activities must be on the basis of fair and legitimate profit and the prohibitions of monopoly and hoarding.

Comparison between Islamic and Conventional Banking

Islamic Banks, like conventional banks, are profitable organizations. Their aim is to gain profit, but they are not allowed to deal with interest or to engage in any business or trade prohibited by Islam. In contrast, traditional conventional banks have as their main goal the maximization of profit subject to a reasonable level of liquidity. They tend to deal with loans only and are keen in engaging themselves in direct investment as a main activity.


The difference between the conventional banking system and the Islamic banking system is that, in the conventional system, interests are given (pre-promised) with a guarantee of repayment and a fixed percentage return while in the Islamic system, investors share a fixed percentage of profit when it occurs i.e. the share of the two practices will vary according to the profit achieved. Banks get back only a share of profit from the business to which it is a party and in case of loss, the business party loses none in terms of money but forgoes the reward for its activities during that period.


It is very important to remember that the Islamic banking movement in the country has only approximately 30 years, so it is unfair to compare its result with those of the conventional banks which have been in existence for almost 300 years.