What is Islamic Banking?

Islamic Banking is a financial structure in keeping with the principles of Islamic Law, or Shari’ah.

The primary guiding principle of Islamic Banking is the ban on the payment of interest, or riba (usury).

This system of finance follows Islamic rules on transactions, or fiqh muamalat, which assert that money be earned not from interest, but from commodities and services.

As trade is permitted, Islamic banking, therefore, encourages asset-based transactions that are ethically sound and just.

In these transactions, the risk is shared between the patron and the financial institution.

How different from Traditional Banking?

The primary difference is traditional banking profits from the charging of interest.

Islamic Banking forbids the charging of interest.

Islamic banks therefore earn money through other means such as those established around the acts of purchasing and selling as prescribed by the Quran.

For example, profit sharing between the patron and the financial institution is allowed, when the earning ratio is predetermined.

The giving and receiving of gifts, by both client and bank, is also permitted.

What types of transactions are allowed?

Financial dealings in line with Islamic rules on transactions, which are rooted in the teachings of the Quran and the Sunnah, as well as other bases for Islamic law, are allowed under the system of Islamic Banking.

Profits from trade and business are permitted through this system, unless they are in opposition to Islamic law.

To guarantee that it acts in accordance with Shari’ah, an Islamic Bank must form an independent religious advisory council, which will guide their business practices and transactions.

The institution’s council will provide oversight regarding Shari’ah compliance through doctrine and ethics. The members will be required to issue fatawah, or religious rulings, regarding the bank’s practices.

They should therefore be scholars of both religion and economics, with experience in banking and finance.

For example, the National Shari’ah Advisory Council in Malaysia oversees the activities of the Bank Negara Malaysia, and is the strongest Shari’ah financial advisory council in the country.

Such a council guides and assists Islamic banks, while providing the patron the assurance that the business practices are in keeping with Islamic morals and ethics.

Each of the different kinds of transactions available from Islamic financial institutions requires council approval.