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Islamic Finance And Islamic Banking Overview
SARA Bouriouche1, YING Zhang2, YUAN Gao1**
(1. Business School, Hohai University, Nanjing 210098;
2. Department of Finance, Hohai University, Nanjing 210098) 5
Brief author introduction:Sara(1987-), Female (Algerian), Master student,research interest:corporate finance
Abstract: The Islamic finance and Islamic banks achieved significant progress in the past two decades.
Islamic finance is based on the principles and mechanisms derived from the provisions of Islamic law.
Their characteristics are composed by the exclusion of the interest rate, sharing of profits and losses,
risk and uncertainty, asset-backed financing and so on. The establishment of these principles, especially
the principle of justice through the prohibition of usury and the adoption of profit-sharing principle 10
make people do not feel aggrieved and exploitation. It proved that the world should welcome the
Islamic finance and Islamic banks, not hamper or curb them.
Key words: Islamic finance; Islamic banking; characteristics; conventional bank.
0 Introduction
The Islamic finance and Islamic banks achieved significant progress in the past two decades, 15
and expanded the acceptance in both Islamic and non-Islamic areas. In 2008, the financial crisis
hit the global economic system, it led to a decline in public confidence to the existing financial
system, and people began to look for a more stable financial system. Since the good performance
of those Islamic banks in some countries, especially in the Gulf countries, more and more western
economists started to do more research to Islamic banks. 20
The British economist Rodney Wilson; who published several papers on Islamic finance,
confirmed that the Islamic banking industry was growing over the past decades. An increasing
numbers of Westerners were skeptical to the conventional banking service they received because
they consider that some services involved unethical exploitation. He said that the emergence of
Islamic banking with its moral system shown the positive face of Islam, and confirmed that the 25
Western banks today in need to an ethical guidance, just because the greed and lack of
morality are the causes of the global crisis in 2008. He added that in the ultimately, the Islamic
banking and the Islamic finance are concerned with the emergence of a distinct Islamic form of
capitalism that can coexist and interact with western capitalism or any other capitalism. So all the
world should welcome the Islamic finance and Islamic banks, not hamper or curb them [1]. The 30
Italian researcher Loretta Napoleoni thought that west can learn many lessons from Islamic
finance [2]. Besides, some other examples also proved that Islamic banks have gained great
importance leading many governments to reconsider about their legislation to the existing bank
system. Now, more and more new Islamic banks or windows offering Islamic financial services
appear in people's field of vision range. 35
1 Overview of Islamic finance
"Islamic" is not only a modifier to the word of finance and financial institution, actually,
Islamic finance is based on the principles and mechanisms derived from the provisions of Islamic
law. That is the fundamental difference with the traditional finance.
Islam is the religion of comprehensive doctrines and Ethics. God created man to worship Him, 40
allowed him to utilize everything on the earth, and expanding the ways of worship in a broad
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sense.
ALLAH forbids usury, deceit, injustice, consuming wealth unlawfully, lying, betrayal,
monopoly, fraud, waste, exploitation and so on. He orders people to be fair, honest, kind, and 45
giving Zakat, etc.
Therefore, Islamic finance and Islamic banks appear some features distinguished from other
conventional finance and institutions. The following sections of this paper will discuss about the
most important characteristics of Islamic finance and Islamic banks.
2 The exclusion of the interest rate 50
The instructions of Islam indicate that people should set up justice and elimination of
exploitation, which means prohibition of all sources of illicit enrichment. In Islam, interest (usury)
is the source of illicit enrichment which God has warned in Chapter two of the holy Quran verse
275. So, the most well-known aspect of Islamic financial system is prohibition of paying or
receiving interest to the capital [3]. Essentially, any positive, fixed, predetermined yield which 55
being guaranteed irrespective of the investment performance, is considered as usury (Riba) and
been prohibited. This prohibition does not mean forbidding the rate of return or profit on capital
which are the earnings of shares, adversely, those are encouraged by Islam. Moreover, profit
determined ex post, symbolizes the creation of additional wealth through successful
entrepreneurship. Whereas interest determined ex ante, is the cost that accrued irrespective to the 60
outcome of business operations, even the business fail.
Islam's prohibition of interest and usury was not unprecedented. The early Jewish and
Christian traditions also forbade Riba: “Do not charge your brother interest, whether on money or
food or anything else that may earn interest.” (Deuteronomy 23:19).
“If you lend money to my people, to the poor among you, you are not to act as a creditor to 65
him; you shall not charge him interest.” The holy bible (American standard bible).
3 SHARING OF PROFITS AND LOSSES
Since interest is prohibited, the supplier of funds turns to the investor, instead of as the
creditor to the enterprise. The providers of financial capital share the business risks with the
entrepreneur, just like they will share the profits as return. Financial transactions follow to the 70
basement rule, that is "sharing profits and losses" or to say, abide the principle "No pains, No
gains".
If two people make a contract for a transaction, and according to the content, one of them
don't need to bear any loss, only to share the profit, we identify the contract itself is invalid
because it breaks the Islamic rules and the logic of justice [4]. That means, sharing the profit and 75
loss is a rule which made by the scholars of Islamic finance as an alternative to the interest rate of
the conventional financial system.
There are several reasons for the prohibition of usury and the imposition of sharing profits
and losses. These reasons can be summarized as following points
Social justice, equality and property rights 80
The prohibition of interest is based on arguments of social justice, equality, and property
rights. Social justice demands that borrowers and lenders share rewards as well as losses in an
equitable fashion. Equality also requests that the process of wealth accumulation and distribution
during the economic activities being fair and representative to the true productivity.
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Prevent the widening gap 85
Interest has a constant tendency in favor of the rich but against of the poor. It will lead to a
widening gap between the rich and the poor. Since rich people can deposit their money to the bank,
then get the benefit from this, thus they can become richer. While, poor people get loans from the
bank to buy what they need, after that, they should pay back the amount of the loans plus the
interest. It will result in worse surroundings for them. 90
Price and effective demands
Since the interest of capital will compose the cost of the goods, and the high cost will lead to
high price, the high price will decrease the effective demands. It's the deviation of economy
towards the abyss of corruption. From this point, we hold the view that banks should prohibit of
Riba, not to deal with interest rate but replace it by the rule of sharing profit and loss. 95
Some Others
1. Interest rate hampers the process of investment and employment, and the community
affected by the usury.
2. Another viewpoint thought that interest causes the monetary crisis and exacerbates the
trade cycles. 100
3. The interest leads to the creation of greed, avarice and selfishness.
4 ASSET-BACKED FINANCING
One of the most important characteristics of Islamic finance is that it is an asset-backed
finance. Islam does not recognize money as a subject-matter of trade, except in some special cases.
Money has no intrinsic utility, and it is only a medium of exchange. Each unit of money is 100% 105
equal to another unit of the same denomination. Therefore, there is no room for making profit
through the exchange of these units inter se. Profit should be generated when something having
intrinsic utility is sold for money or when different currencies are exchanged, one for another. If
the profit earned through dealing with money (of the same currency) or the papers representing
them is interest, it would be prohibited [6]. So, we can say, financing in Islam is always based on 110
illiquid assets which can create real assets or inventories.
5 RISK AND UNCERTAINTY (GHARAR)
The legal school in Islam defines Gharar as "that whose nature and consequences are
hidden." or "that which admits two possibilities, with the less desirable one being more likely." It
means, contractual risk and speculative behavior are also not allowed in accordance with the rule 115
of Islam. In general, it prohibits selling goods or service for which the seller is not in a position to
deliver [7]. Also, the matter of making a contract which is conditional on an unknown event is
forbidden. People cannot sell anything they do not own. Moreover, the transaction price and the
nature of goods are defined in detail. It must be mutually agreed upon results. Thereby, it will
avoid the kind of sale which maybe represent a gamble (ie, conventional short sales or sales on 120
margin are prohibited).
6 COMMITMENT TO THE PRINCIPLE OF HALAL
(PERMITTED) AND HARAM (PROHIBITED) WHEN
DEALING
This means it is not permitted to deal with the transaction or finance for the trade which is 125
forbidden by Qur’an [8], just like pork transaction (The Qur’an prohibits pork in no less than 4
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different places); wine and alcohol are also being banned.
7 Conclusion
In this paper we introduce the Islamic finance principals, from these explanations to the
characteristics of Islamic finance; we can find that there are several fundamental differences 130
between Islamic banks and conventional banks, which can be summarized as follows:
All in all, through what we presented, we find that the characteristics of Islamic finance are
the things that attract people to do follow them. The establishment of the principle of justice
through the prohibition of usury and the adoption of profit-sharing principle make people do not 135
feel aggrieved and exploitation. On the country, these principles encourage people to work harder
for making more profits and then avoiding losses. They also encourage the savings owner to invest
to the productive projects, by this way; they can get the profits, not only deposit to the banks and
get the steady returns from the banks.
Anyway, it should be noted that in spite of these successes achieved by the Islamic finance 140
and banks, they still need to face the challenges to get more development.
References
[1] ,"British Banking Expert: Islamic finance alternative to conventional banks" [N],ASHARQ
AL-AWSAT,November 2008 (No 10948) 145
[2] L. Napoleoni, "Rogue Economics"[M], Seven Stories Press, 2008.
[3] ,"Islamic Finance: An Ethical Alternative to Conventional Finance" [J], An ACCA discussion paper,
August 2008,page 3.
[4] S. Nacer, Islamic Banks [Z], International Forum on the Global Financial Crisis and Islamic Banks, Algeria,
April 7th 8th, 2009, pages 4, (Arabic) 150
[5] M. El Nouri, "Islamic Banks in Europe in Europe: Tracks, Challenges and Prospects [Z].The Nineteenth
Session of the European Council for Fatwa and Research, Istanbul, July 2009.(Arabic)
[6] Mufti Muhammad Taqi Usmani, "An Introduction to Islamic Financ" [OL], page in:
1mmad+Taq%C4%AB+%CA%BBUs%CC%B2m%C4%81n%C4%AB%22&hl=en&sa=X&ei=bWtRUeDeAsLE155
kwXAmIDwDg&ved=0CC8Q6AEwAA#v=onepage&q&f=false
[7] S. Nacer, "The Development of Short-Term Funding Formulas in Islamic Banks [M], Tourath association,
Algeria, 2002, page 54, (Arabic).
[8] Hamad Farooq Al Shaikh, "Al Mufeed in Transactions of Islamic Banks" [M], Bahrain Islamic bank, 2010,
page 11. (Arabic) 160
Islamic banks Conventional banks
* It operates in accordance with the
rules of Shariah, the legal code of Islam.
*It is based on the principle of
prohibition of usury and sharing profits
and losses to achieve the social justice.
*Its intermediation is asset based and is
driven by risk sharing.
*It contributes to fair distribution of
income and wealth. It takes into account
the principle of compassion and
humanitarian aspect.
*It contributes to the development
process. This is because it uses the
money or the deposits collected in
investment operations (musharakah,
mudarabah.)
*It operates in accordance to man-made
laws and international conventions.
*It is based on interest rate or usury
which used to attract the depositors
*Its intermediation is debt based and
allows for risk transfer.
*It contributes to widen the gap between
the rich and the poor.
*It does not care about the development;
it's only interested in collecting profits
through the collection of deposits and
providing of loans with greater rate of
interest.
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伊斯兰金融和伊斯兰银行特征研究
萨拉1，张颖2，高媛1
（1. 商学院，河海大学，南京 210098； 165
2. Department of Finance, Hohai University, Nanjing 210098）
摘要：在过去的 20年，伊斯兰金融以及伊斯兰银行都获得了意义重大的发展。伊斯兰金融
建立的基础是伊斯兰律法所衍生出的原则和机制，具有禁止利息，利润和损失共担，存在风
险和不确定性，实物资产抵押融资等特点。这些原则的确立，特别是通过禁止高利贷以及采
用利润共享所体现的公平原则使人们的利益不易受到侵害和剥削。事实证明，世界应该接纳170
伊斯兰金融以及伊斯兰银行而不是妨碍和束缚其发展。
关键词：伊斯兰金融；伊斯兰银行；特征；传统银行
中图分类号：F831
