The essence of Islamic banking lies in the rejection of interest for loaning of money and in only making investments in businesses that provide goods or services that are consistent with Islamic principles. It is a relatively new field in modern banking. The first Islamic banks appeared in the late 20th century with the help and guidance of world renowned Islamic scholars and financial experts to apply Sharia-compliant banking principles to private and semi-private commercial institutions around the world.
Modes of Islamic Transactions
Islamic banking is commonly based around the following transaction modes, mentioned here with their traditional banking counterparts:
- Mudharabah – Profit sharing
- Musharakah – Joint venture
- Wadiah – Safe keeping
- Murabahah – Sell & buy or cost plus
- Ijarah – Leasing
- Bai’ Salam – Contract of advance payment
- Sukuk – Bonds
- Takaful – Insurance
Some Common Criticisms of Islamic Finance/Banking
Islamic banking is far from perfect; therefore, it has drawn its fair share of criticism as well. The Islamic banking industry remains somewhat controversial to date and the question of whether or not Islamic banking is really Islamic remains a topic of discussion and a hot debates among the Islamic economists and bankers as well as among the general public. Still, despite the criticism, it may still be a better alternative to traditional, interest-based banking.
Critics most commonly claim that Islamic banking essentially mimics conventional banking in terms of interest based financial transactions. They suggest that by simply renaming interest to “profit” or “compensation for deferred payment”, Islamic banks are only deceiving people into believing that they are complying with the Shariah (Islamic Law). In an article in late 2007, Mr. Salman Ahmed Sheikh claimed that there is basically no difference in the Islamic and conventional modes of financing. In his opinion, the only differences are procedural, which are minor and do not change the nature of the transactions.
In response, an influential Shariah scholar stated that the essence of Islamic financing lies in actual economic activity, and is therefore different from interest-based lending. According to Reuters, Prof. Ali Al Qaradaghi gave an interview at the International Shariah Scholars Forum 09 (ISSF09), clarifying that the issue is the structure of these instruments and contracts and the burden of responsibility. He further stated that the interest in interest-bearing loans is something that is guaranteed to the lender and he undertakes absolutely no risk at all. In the Murabaha transaction for example, the bank undertakes responsibility if the commodity (such as a car) should be damaged or destroyed during the period. Compare this with conventional car financing where the responsibility lies with the individual, not the bank.
By highlighting this key difference between Islamic and conventional banking, the scholar has also indirectly pinpointed one of the reasons why more nations have been looking into Islamic finance since the financial crisis.
Comparing Islamic Banking with Conventional Banking
Unlike traditional banking, Islamic banking can only be based on transactions whose source and objective is in accordance with Islamic law. As a result, Islamic banks offer no support for projects that involve activities that are against Islamic teachings. All transactions are purely based on halal investing and halal purchasing.
Conventional banking is mainly concerned with the elimination of risk from financial transactions, whereas Islamic banking places the burden of risk on the bank, while the labor responsibility rests with the customer. Islamic banks bear the liability in their transactions with customers. On the other hand, conventional banks are not liable for any losses, which are fully borne by the customer. This difference stems from the Islamic law that any profit without bearing risk or liability is not permissible.
Islamic banking has a long way to go before it can be called Islamic in the true sense. But there is a lot of work being done to improve Islamic financial products and to make them more relevant by fitting them into the capitalist economy, developing systems that allow Islamic banks to be fully recognized by financial regulatory authorities around the world, and to bring complete uniformity in the financial and accounting practices of these banks.
At this point, Islamic banking can only be considered the lesser of two evils. It is still a better alternative for those who try to adhere to Islamic law with the hope that one day they will have an Islamic banking system that cannot be degraded with the label of “imperfect”.
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The present Economic system is not in accordance with Islamic principles, but what alternative does a person have when whole of the Economy is based on this type of Banking?
Keep on struggling against capitalist economy and bring a revolution by demolishing that system . .!!
$tand up for revolution
Stand with UNITED PAKISTAN
there is a very significant difference between Islamic and conventional banking. conventional banking is based on interest and islamic banking is based on trade. I had a very similar reaction before i took the islamic banking course in my university. i know people use the very common argument of KIBOR (Some above are saying LIBOR which have nothing to do with retail banking in Pakistan; i blame lack of knowledge) is used in Islamic banking, well yes it is used but just for the sake of benchmarking., because conventional banks use KIBOR for interest, Islamic bank use same KIBOR for profit calculations and it is fixed before the contract. ( if islamic bank do not do that then they will not be competitive in Banking industry of Pakistan. the majority of the above mentioned islamic products put the risk on islamic banks while conventional banks never takes risk on itself. Islamic mode of Insurance is Takaful which is increasing at a very high rate. until takaful is not reached to its potential or to the most people, they have to mitigate their risk through some where so they might be using conventional insurance which is still wrong in my opinion.
Their rate of interest/profit goes hand in hand with libor rate or bank of england rate.
They charge more than the conventional banks
The person who takes the loan is at risk of loosing home just like the conventional banking mortgage
They say the house is co-owned but this is the same in conventional banking as you can read the deeds of your house which clearly says that the bank owns the house, at least has share in it.
If islamic banking says that the owner has absolute ownership of the part of the property than why do they not let the owner rent his part of the property. Why do they charge extra more for the buy to let property mortgage. I never felt convenient with the term islamic mortgage and I feel that it is just an eye wash. I may be wrong, may Allah swt forgive me.
This article says islamic bank take share in damage to the property etc but here in uk they ask for home insurance just like any other bank. They will never be at loss as they will always recover their due amount and in that process the person taking the loan only suffers. Just like conventional banking.
Can any one clear my doubts please?
As every muslim know s the religion rules every thing.islam is a way of life as well so the way you are living and spending money is affected by this. By the way as I am living in Europe now I choose Islamic banking as the lesser of evil as said in tje article which explained very well the point
Bottomline: any financial system that makes the rich richer and poor poorer, any system that takes wealth from the majority and concentrates it in the hands of a few, any system that exploits the need of a poor person – that is concept of usury; that is what is not good.
Whether the label is ‘islamic finance/islamic banking’ or something else, if the system has any of these features then it is prohibited.
The best way to lend is to give consumer choices. Interest base loan or partnership? Paying interest or sharing profit? In Conventional banking system these choices are absent? I give you $100 dollars with 18% interest you give me 5 cent daily until you give me back my $100. There is no question of why you need $100 what do you want to do with it. If we say I give you 100 and you buy two sheeps and look after it and multiply it and turn that to Profit We shared the profit and take 30% pluse the 100 and if you loss the sheep to sickness for example I only take back my 100 since there was no profit to share. That is fair. If we call it Islamic or sharia why not banks give that option and become partners in businesses to assure return on investment on both ends. It is a good added product for risk managers to consider.
The research upon the system of banking should be thorougly done with regards to the qur’an nd the sunnah. Is a field i am tinking of studying. May Allah guide us aright. Ameen
Dear all, Assalaamu alaikum
I have gone through all the above comments and articles. I’m estonished to see that the very basic and fundamental principle is either overlooked intentionally, or forgotten mistakenly. And that principle is hidden in the term ISLAMIC. When a person embraces ISLAM, what does he do? In his very first step he denies each n every worship able being and his second step is to announce that Only Allah Has a right to be worshipped. Now, after this very moment this denial and announcing stands for him throughout his life and in every walk thereof. Keep this principle in mind and then consider, like every other aspect, the aspect of banking. A MUSLIM person or a MUSLIM society MUST decide, in the very first step, to REJECT all prevailing economic systems (of which the modern banking is merely a sector or branch) and the whole economic/financial system (including banking) should be reconstructed (not modified) in the light of Islamic Shariah’s directives. UNTIL AND UNLESS THIS IS DONE, we can never achieve the goal of establishing a real Islamic banking and its benefits to the humanity, as promised in Shariah.
that is my dream which come through i want any one to stand for interest problem which is haram
The interest based economies are run by the banks and banker. Every laws that are in the books as regulation or otherwise, is there to protect the bank and the banker’s interest. They take no risk. A house title is held until the mortgage principle and all interest is paid by borrower. In addition the borrower insure the property and pay taxes and maintenance. What the bank does is basically borrow the money from Fed Reserve with prime, then add a margin to it and hold a title to a property as mortgage. If the property value goes down, there are no adjustments, or correction. The only reason I like the so called Islamic banking, which I prefer to call it fair banking, is that the risk and profit is shared. You do not need a lawyer or law to inforce the unfair contract. All parties calculate the risk, expense, profit and share that. Why is it hard to do that because those who are profiting from interest based system have created they own federal branch bank called federal reserve and who can fight the Feds but one of their own?
Wants more elaboration
@Sakim: i think u r not aware about the banking system. Religion is not only offer prayers, zakhah, fasting it gives us guidance about our whole life and banking system is not out off that.
islamic or non islamic
what’s the use of religion in this sector anyway?
I am Salman Ahmed Shaikh who is cited in the article. My most recent criticism on Islamic banking can be read at:
Ever since, I started as a student of Islamic Economics at IIU, Islamabad during 1985-1990, we have been taught almost all the modes of financing in Isĺamic Economics. A lot of questions are still un resolved. The problem with this delay in change is that we want to Islamize the prevailing system. In this parsuit we make delibrate/ inadvertant mistakes. We can’t achieve our goal unless we develop a new set of procedures and practices. Mudarbah, Musharika, and all other methods are the same as conventional banking. The example of risk in car finance in this article is very Naive as all the banks are covered by insurance companies which again are non-islamic. The Islamic Banks can’t implement Mudarbah or Mushirka in true spirit as the moral standards of prevailing society are very poor and un -reIiable. People tend to cheat as and when there is some space. To me this the most challenging hazard in developing Islamic tools of banking and finance.