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Islamic Finance A Practical Perspective

  • Book Title:
 Islamic Finance A Practical Perspective
  • Book Author:
Bala Shanmugam, Lokesh Gupta, Nafis Alam
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Syariah-approved Activities

Islamic banks participate in business activities that do not violate the rules of Syariah. For example, any investment in businesses dealing with alcohol, gambling, and casinos would be strictly prohibited. As such, Islamic banks are expected to establish a Syariah Supervisory Board consisting of Syariah jurists who act as independent Syariah auditors and advisors to the banks. They will be responsible for ensuring that the practices and activities of Islamic banks do not contradict Islamic ethics.

1.4 Islamic Banking Evolution

Islamic banking was an abstract concept until the first half of the twentieth century. However, it has now developed into a full-fledged system and discipline. Islamic banking first started in Egypt at Mit Ghamr by Ahmad El Najjar in 1963. This bank neither paid nor charged any interest to investors and borrowers. It invested mainly in trade and industry. The profits made by the bank were paid to investors. The experiment, however, lasted only until 1967.

Islamic banking, with a very different approach to that in Egypt, also emerged in Malaysia. It was a financial institution developed for Malaysian Muslims undertaking the pilgrimage to Mecca and Medina. This institution called Lembaga Tabung Haji (Pilgrims Fund Board, Malaysia) was set up to help Muslims save for their pilgrimage expenses.

In 1971, the Naseer Social Bank was established in Egypt, and was declared an interest-free commercial bank, although its charter made no reference to Syariah. In the 1970s, changes took place in the political cli-mate of many Muslim nations which facilitated the establishment of Islamic financial institutions.

A number of Islamic banks came into existence in the Middle East during this period: the Islamic Development Bank (1975), the Dubai Islamic Bank (l975), the Faisal Islamic Bank of Sudan (l977), the Faisal Islamic Bank of Egypt (l977), and the Bahrain Islamic Bank (l979) to mention a few. Islamic banking made its debut in Malaysia in 1983 with the establishment of Bank Islam Malaysia Berhad (BIMB).

Since then, Islamic banks and financial houses have been established in Qatar, Sudan, Bahrain, Bangladesh, Indonesia, Senegal, Guinea, Denmark, Switzerland, Turkey, England, Jordan, Tunisia, and Mauritania.

Islamic Economics

Islamic banks are financial institutions established to promote Islamic economics. An Islamic economy is a market economy guided by moral values. Islam differs essentially from capitalism and socialism in the nature of ownership. Islam has given detailed regulations for economic life, which is balanced and fair. According to the Quran, everything on this earth belongs to Allah the Almighty.

Man is a mere trustee and he is accountable to Him, in accordance with the rules laid down in the Syariah. As such, economic activities are based on the principles of cooperation and responsibility that are ethically guided, and aimed at establishing a just society wherein everyone will behave responsibly and honestly. The fundamental principles of an Islamic economic system are listed below.

•              Socio-economic Justice and Equitable Distribution

The essential feature of Islamic economics is that it is meant to establish socio-economic justice. Socio-economic justice comprises of two principles. The first principle is of general mutual responsibility and the second is about social balance.

Islam encourages businesses to be carried out in an honest way that facilitates mutual benefit to the parties involved. Islam also encourages the practice of trade, just as it has denounced the injustices of interest. The focus is to achieve win/win outcomes while avoiding ‘win/lose’ or ‘lose/lose’ ones. This ‘win/win’ framework leads to better economic behavior and performance and thus promises a better future. The essence is the abolition of exploitation.

•              Trading of Forbidden Objects

Islam prohibits the trading of forbidden or unclean objects such as pigs; production, sale, and distribution of alcohol; fortune-telling, and so on. These activities are considered haram (non-permissible). In addition to these, certain objects are clean but not tradable, such as the soil of holy places. Haram is defined as ‘not permitted, not allowed, unauthorised, unapproved, unsanctioned, unlawful, illegal, illegit-mate or illicit;. As such, every Muslim has to ensure that any economic activity done by them should not involve any haram element.

•              Trusteeship

Islam has stressed that everything in this universe belongs to Allah the Almighty and He is the owner of everything. Allah has made man a trustee. Man is accountable to Allah the Almighty for the utilization of these resources. Realization of this dual ownership mitigates the selfish and dishonest tendencies that often crop up from the notion of absolute ownership.

The idea of trusteeship distinguishes the Islamic approach to economics from materialistic approaches like capitalism and socialism, and introduces a moral and spiritual element into business life. Absolute ownership by man is an alien concept in Islam.

There are also definite obligations to be adhered to by man. An example is that it is forbidden to gain ownership of property or wealth by fraud, deceit, theft, or other falsehoods. Property can be acquired by combining one’s labor with natural resources. Rights also can be transferred in exchange for a counter-value of the same worth or as a gift.

•              Prohibition of Hoarding

Islam prohibits hoarding of food, money, and other basic necessities as this practice is recognized as wasting of wealth. This principle rules out the seeking of economic gains at the cost of moral and spiritual values, both at the individual and the societal levels. It follows that savings (what is left after consumption and charitable giving) must be put to good use. Islam encourages investment in trade that in turn will gener-ate revenue. This can be shared based on the profit- and loss-sharing concept, which will be productive for the community and can bring about economic prosperity. The important lesson is that Islam prohib-its wealth hoarding and encourages investments that benefit the community.

•              Spirit of Cooperation

Islam requires that every man should give the needy a specified portion of his wealth. This contribution is called zakat which is a levy on certain categories of wealth. The importance of zakat is that it is one of the five pillars of Islam, the others being belief, prayers, fasting, and haj. Zakat is usually about 2.5% of personal wealth. Zakat is a means of narrowing the gap between the rich and the poor and to ensure that everyone’s needs are met.

A society can flourish only when its members do not spend all their wealth on satisfying their own desires but reserve a portion of it for their parents, relatives, neighbors, the poor, and the incapacitated. The principle of zakat is to take from those who have wealth and give it away to those who do not. This redistribution of wealth is a way to reduce social inequality.

•              The Duality of Risk

Islam has a dual conception of risk. On the one hand, it considers the partial acceptance of liability (for risk) in a productive venture as legiti-mate for a share in profit. On the other hand, risk should always be taken cautiously. Excessive and uncontrollable risks or obligations should be avoided as it leads to speculation. For example, the sale of an object which the seller does not yet possess is strictly prohibited. In addition, gambling and speculation are also forbidden. In business terms, the object of a contract must be known, ascertained, and in existence when the contract is concluded.

•              No Gain Without Either Effort or Liability

Islam recognizes money as a medium of exchange and not a commodity for exchange. Hence, any reward generated from the mere post ponement of consumption, that is, savings, is not a justification for compensation, that is, riba or interest. Islam is not opposed to profit or financial gain, as long as:

 (a)         An effort is performed, or (partial) liability is accepted for the financial result of a venture.

 (b)         The effort or venture was productive, that is, it led to an increase of value.

 (c)          The profit was made in line with Syariah guidelines.

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