Information about Islamic BankingIslamic Banking and Finance- Global growth trends.
Islamic banking and finance growth has generated considerable interest in the financial world in recent years. The concept of Islamic banking has received encouraging response from different corners of the globe as one discovers its ideological dimensions and practical significance.
Given its ability to offer innovative financial solutions for basic financial needs in under-served markets espacially in the Muslim world and to meet complex financial requirements of the modern times, it is seen as a socially responsible and ethical banking model with considerable growth potential. In the Muslim world and increasingly in the West, significant segments statements of the institutional and retail markets are choosing Islamic finance for their financing and investment needs. Islamic financial system also draws its strength from it being asset backed nature and directly linkage to the real economic transactions and avoidance of any element of interest and speculative activity.
Understanding the difference:When we look at the difference between Islamic Financial Institutes and the interest based conventional institutions, we find out that the differences are on three levels:
1. Conceptual and Socio religious level.
2. Business model and governing framework.
3. Product Level Implementation.
Without a clear understanding of these differences, some people, even experts tend to make a common mistake of equating Islamic banks with other conventional banks with mere change of name.
1. In a conventional Bank the relationship between the bank and customer is that of creditor and debtor and any benefit available to either party falls under the ambit of interest since it is a gain on Debt/Loan. In Islamic Banking, the relationship between bank anf customer differ as per the modes of finace and thenature of the facility.
2. In Sale based transaction modes, Islamic Banks and the customer assume the role of seller and buyer respectively and any benefit available to either party is profit on Sale Trannsaction.
3. In rental based modes, the relationship between Islamic bank and customer is that Lessor and Lesssee respectively and any benefit available to bank is in the form of Rent.
4. In Participation based modes, the relationship between Islamic bank and customer is that of partnership and the gain is raken by either party is profit on Musharakah.
In Service based mode, the relationship between Islamic bank and customer is of Mustajir (Service Provider) and Ajeer( To whom service is given) respectively and islamic bank gets remuneration in the form of fees(Ujrat).
Islamic Banking How is Interest free?
Islamic banks like other banks is an institution whose main business is to mobilize funds from savers and user these funds to finance the economic activities of businessmen. While a conventional bank uses the rate of interest for both obtaining funds from savers and lending these funds to businessmen. An Islamic bank performs these functions using various financial modes which are compatible with the Shariah. For mobilizing resources, it uses either the contract of Mudarabah or Wakalah with the funds owners. Under in first contract, the net income of the bank is shared between fund owners and fund providers according to a predetermined profit sharing formula. In the case of loss, the same is shared by fund providers in proportion to the capital contribution. As far as the nature of investment deposits are concerned, these could be either general investment deposit or specific investments’ accounts in which deposits are made for investment in particular projects. In addition, there are current accounts are in nature of an interest free loan to bank. The bank guarantees, the principle in case of current accounts but pays no profit on such accounts.Under the Wakalah contract, clients give funds to the bank that serve as their investment manager. The bank charges a predetermined fee for its managerial services. The profit on to the fund after deducting such a fee. On the assets side, the bank uses a number of financial instruments none of which involves interest.
Financing in Islamic Banks
Question: If the Islamic banks do not lend money on interest then what modes of financing can be used for the following:
Trade and industrial finance
Financing the budget deficit
Acquiring foreign loans
As a matter of principle, all the financial transactions between the parties are lawful in the eyes of Islamic Shariah. Islamic Shariah provides several interest-free modes of finance that can be used to satisfy various business needs of the customer. These modes can be clubbed into two main categories.
The 1st may include modes of advancing funds on a profit-and-loss-sharing basis. ( Mudarabah, Musharakah ).
The 2nd may include the modes of finance in which are used for the purchase/hire of goods and services on a fixed return basis. (Murabaha, Istisna, Salam & Ijara).
A) Modes for financing trade and industry:
Muarabaha, Musawama, Ijara and Salam are particularly suitable for trade while istisna is especially suitable for manufacturing or construction industry. Murabaha can be used for the financing of all purchase of raw materials and inventory. For the procurement of fixed assets including plant and machinery, building etc. either Diminishing Musharakah or Ijara can be more feasible.
B) Modes for the financing a budget deficit:
It is noted that in an Islamic state, all the efforts should be made to avoid the budget deficit.
However, in case of unavoidable circumstances, the budget deficit may be kept to the possible minimum limit. Sometimes the budget deficit is seen as a result of either extravagant expenditure or inefficient effort to generate tax revenue due too political, economic reasons or otherwise. There is a need to win public confidence about these needs and to create transparency in government expenditure. This can serve better in keeping budget deficit to minimum level. In case of unavoidable deficit, government-owned enterprises can obtain finance by way of Mudarabah, Musharakah or Sukuk, just like private companies do.