How Islamic Banks Work in Practice - Essay Example

Islamic Banking Name Institution Date Table of contents Executive Summary 3 Introduction 4 How Islamic banks work in practice 4 Evaluation and analysis of three products 5 Istisna 6 Murabahah 7 Mudarabah 7 Recommendations 9 Conclusion 10 References 11 Islamic Banking Executive Summary Islamic banking is a phenomenon that entails conforming to shariah or the holy Qur’an. The conventional banking is largely based of collection of interest on loan and borrowing. Islamic banking dissents from this approach and conforms to the teaching contained in the Qur’an. This paper commences with a background of the chosen company: HSBC (Amana), and also provides an introduction of the topic under discussion. The working or practice of Islamic banks is explored in the section that follows. The transactions in Islamic banks do not involve riba or interest. Cost sharing and fairness are encouraged in every transaction. The operations have to meet the condition stipulated in the shariah and the transactions involved have to be genuine. Islamic banking is characterized by instruments of transaction used in the operations. Three of the instruments/products have been discussed in this paper. The products have been analysed and evaluated in this paper. The recommendations provide guidelines that can be used to improve Islamic banking while sticking to the stipulated principles in the shariah. A recap of the main arguments of the paper is offered in the conclusion section. Islamic banking has both strengths and weaknesses. A list of references which includes material consulted has been offered in the last section of this paper. Introduction How Islamic banks work in practice Islamic banking is banking system which conforms to the ethos, spirit, and value system of Islam and governed by the principles spelt out in the Islamic Shariah. Islamic banking practices are duly approved by Islamic law. Islamic banking can also be known as Shariah compliant banking system. Islamic banking that is interest free is a concept that represents a number of banking operations and instruments which do not include interest. Islamic banking generally targets to avoid transactions that are interest-based according to Islamic Shariah and also focuses on avoiding un-social and unethical practices (Kuran, 2005). The Sunnah and the Qur’an provides guidance for Islamic banking. In practice, Islamic banking entails changing of conventional money lending in transactions which are based on real services and tangible assets. The means of the system of Islamic banking targets the attainment of an economic prosperity. Islamic banking does not involve interest or riba at all. Riba is the extra amount sought over the initial principal invested. A debt or a loan is not expected to fetch any extra amount apart from the initial amount invested or borrowed. The transactions involve in possess an element of Maiser or Gharar. Islamic banking does not involve any transaction whose subject is invalid or is considered as haram is the perception of Islam. The business or transaction has to be legal and genuine. Islamic banks deal with getting returns through tools of investment that are compliant to the Shariah. Islamic banking operations are based on sharing the risk which may come about through investment and trading activities applying contracts of various modes of finance that are Islamic (Mahlknecht, 2009). The teaching or Qur’an are against riba or interest which is the basis of operations of other commercial banks and financial institutions. Riba has been prohibited in the Qur’an for true believers of Allah. Islamic banking is developed from the Islamic injunction of interest or riba. Islamic teaching is against interest on loans despite the purpose and nature of the transaction. Prohibition of riba is targeted at eliminating exploitation and excesses that take place in consumption loans when issued on interest (Saeed, 1996). Islamic banking demands that no one has to engage in economic activities which are not allowed by the Shariah. Investment in immoral activities such as pornography or being involved in drugs, alcohol or gambling is contrary to the Shariah. Islamic banking involves sanctity of contract. The parties involved in Islamic banking transaction have to confirm the transaction is valid or halal in the perceptive of Islamic Shariah. The transactions do not have to be voidable and invalid. Shariah ruling is the one that make a transaction valid. Secondly, risk sharing is another principle involved in Islamic banking. Profit cannot be earned on a capital or asset unless ownership risks have been absorbed by the earner. The ownership of risks has to proceed the earning of profit (Munawar, 2007). Each Islamic banking transaction has certain economic activity or purpose. Islamic transactions are normally backed by real service or tangible asset. Fairness is also another principle that applies in Islamic banking. Transaction based on dubious conditions and terms cannot be allowed in Islamic banking. No any subject matter that is invalid should be involved in Islamic banking. Evaluation and analysis of three products There are a number of instruments or products that are offered by HSBC Amanah. Most of these products are either personal or corporate. Mudarabah can be offered by an individual or corporate. It is important for any transaction to observe the Shariah and the holy Qur’an. HSBC Amanah takes part in the Moslem pilgrimage to Mecca: Hajj so as to showcase the kind of products which are being offered by the company. Istisna This is a form of forward sales contract; a financing mechanism that is long-term under which a price is agreed upon prior to building the asset described in the agreement. Sellers have the option of subcontracting of creating the asset themselves. Buyers can either pay the whole amount in advance or pay in installment in the course of manufacturing. Istisna in Arabic means asking an individual to manufacture. This is a kind of financing that is commonly practiced in the industry of construction. This type of Bai (sale) allows the sale of a commodity prior to its creation or manufacture. Istisna is supported by Shariah scholars since it is devoid of any prohibition (Dr. Usmani, 2002). The instrument is legalized on the principles of Istihsan or public interest. Istisna is a type of agreement that results in a sale at a price whereby the buyer orders to construct, assemble, or manufacture a product that will be availed at an agreed future time or date. The manufacturer has to deliver the asset adhering to the specifications without failing to note the agreed dates or time. The parties contracting need to renew an exchange of acceptance and offer after the preparation of the subject matter (Warde, 2000). The contract can be cancelled when prior notice is given by either party prior to manufacturing process commencement by the party mandated to do so. Just like any other Islamic bank, HSBC Amanah makes sure that it follows all rules of Islamic banking when dealing with Istisna. HSBC Amanah ensures that all Shariah scholars maintain objectivity and keep secret all information considered sensitive. Independent Shariah scholars are employed by the bank to ensure that the services offered by HSBC Amanah meet the standard required according to Shariah. Murabahah This is a type of ‘cost-plus’ transaction whereby the bank purchases the asset and proceeds immediately to sell it to a willing client at a pre-agreed price which is payable in installments. The price is determined at a level which takes into consideration the time value of money until the monthly installments paid by customer cover the selling price of the bank, minus any deposit that may have been paid. This instrument of Islamic banking can be used by mainstream banking customers seeking a mortgage when considering buying of property. Murabaha enables short-term financing to take place (Schoon, 2010). Murabahah has different uses. Murabaha is used in purchase of equipment, materials, merchandise, and goods; export financing, importing of merchandise and goods, and other types of financing that involves working capital nature. A lot of financing transactions involved in Islamic banking involves Murabaha. HSBC murabahah involves funds being invested in commodities or metals which are later sold to the bank in exchange for a profit which is pre-determined. The profit is payable after the predetermined period of investment. HSBC Amanah has murabahah as one of its investment options that sees transactions happening within its banking section. It is in the interest of the bank to ensure that all its products are Shariah-compliant. Mudarabah This is a type of investment partnership between a business and a business that shares the profits/losses and risk between both parties at levels that are pre-agreed. A mudaraba transaction bring some of the gains of a business loan shariah-compliant effectively needs to take a stake in business. Clients invest their expertise and time in the enterprise running. Mudarabah partnership involves one party providing expertise while the other offers funds. The partners who offer the money are known as ‘Rab-ul-Maal’. The ratio of profit sharing is calculated at the time of the inception of the Mudarabah (Rammal & Zurbruegg, 2007). On the other hand, where loss is realized, it is borne by only Rab-ul-Maal. The depositors are called Rab-ul-Maal and the bank is known as Mudarib. There are two kinds of Mudarabah. The first kind is known as Al-Mudarabah Al-Muqayyada; in this case the depositor states a specific business or pace for the bank where he can invest his money. This is also known as restricted Mudarabah. The second type is known as Al-Mudarabah Al-Mutlaqah. The depositor provides full freedom to the bank to take part in any business that he considers fit. This is also referred to as unrestricted Mudarabah. It is important for the sake of the Mudarabah’s validity for the parties to agree on a particular formula of profit sharing from the commencement of the contract. The Shariah does not stipulate any particular formulae of proportion but it leaves the matter at the discretion of the consenting parties (Banaji, 2007). For management of deposit, Islamic banks come up with various pools of investment while at the same time observing the maturity and risk profile of the depositors. The customers’ deposits are kept in these pools and profit generated is distributed between the depositors and the bank using weightages determined at the time of the agreement. Agreement concerning or regarding mudarabah cannot permit a lump sum profit for any party and it cannot determine the share to be received by any party at a particular rate which is tied up with capital. Under investments that are mudarabah-based, funds earn a return based on a profit sharing principle. The funds are invested in the bank in Shariah-compliant way. Profits which are realized from the mudarabah investment will be shared on a profit-sharing ration that is pre-determined. HSBC Amanah has also current accounts, savings, and term investment accounts. HSBC strives to make sure that the account services are Shariah-compliant and serve Moslems without any problem. Investment accounts of entail short to medium term solutions of investments which earn returns through mudarabah contracts and murabahah contracts. Recommendations Islamic banking has grown in lips and bounds since it was first practiced in countries that adhere to Islamic shariah laws and the Qur’an. Despite the progress registered in Islamic banking, there are still many things that have to be done to increase efficiency, accountability, and productivity in Islamic banking (Ausaf, 1987). Islamic banking exists parallel with conventional banking many countries in the world. In countries where the number of Muslims are few, there are also few banks that adhere to Islamic banking that do not at all encourage the collection or demand for interest in any transaction. The instruments or products used in Islamic banking are very few and there is need for architects of Islamic banking to come up with more products that can diversify risks as well as provide variety to the customers. Few products that offer required transaction make the Muslim faithful to have very limited options when transacting. Forms of loans and products of transactions have to be increased to cater for increasing demands of customers. Islamic banking has to borrow a leaf from the conventional baking but adhere to the teaching of the Qur’an. There many Muslims who would want to follow the teaching of the Qur’an on riba but they cannot because of few branches or total absent of banks that adhere to Islamic kind of banking in the places of resident or work. Consequently, it is important for more branches of banks adhering to Islamic banking to be spread to many parts of the world. Islamic banks have to take the initiative of organizing workshops, open forums, field days, and seminars to sensitize the people on the features of Islamic banking and why they should adhere to Islamic banking as explained in the holy scripture of the Qur’an or shariah law. Guide books on Islamic banking have to be provided at strategic places in the bank so that they offer knowledge to clients who are not fully equipped. Professionals who are conversant with Islamic banking have to visit institutions of higher learning to teach Muslims faithful of Islamic banking. Islamic banking is important in the live of Muslims who want to observe the teaching of the holy Qur’an. Conclusion Since the commencement of Islam in 570A.D. through Prophet Muhammad (may peace be upon him), Islamic banking has grown to reach where it is today. Convectional banking has taken centre stage in many countries. Where Muslims are few, they are found a problem transacting. The principles of Islamic banking echoes the teaching found in the shariah and Qur’an. The transactions have to be fair, halal, and adhering to all principles explained in the Qur’an. There are products which are applied while transacting in Islamic banking. Some these products include mudarabah, murabahah, and Istisna. The various transactions are used in meeting the transaction needs of clients. The transactions have to be guided by the teachings of the Qur’an. There is still room for improvement to make Islamic banking in the world. References Ausaf, A. (1987). Development and problems of Islamic banks, Jeddah: Islamic research and training institute. Banaji, J. (2007). Islam, the Mediterranean and the rise of capitalism", Historical Materialism, 15 (1): 47–74Munawar, I. (2007). A Guide to Islamic Finance. London: Risk Books. Dr. Usmani, M.I. A. (2002). Meezan Bank’s Guide to Islamic Banking, Darul Ishaat, Karachi, Pakistan. Kuran, T. (2005). The Absence of the Corporation in Islamic Law: Origins and Persistence, American Journal of Comparative Law 53, (798–9): 785–834 Mahlknecht, M. (2009). Islamic Capital Markets and Risk Management. London: Risk Books Rammal, H. G. & Zurbruegg, R. (2007). Awareness of Islamic Banking Products Among Muslims: The Case of Australia. Journal of Financial Services Marketing, 12(1), 65-74. .Saeed, A. (1996). Islamic Banking and Interest: A Study of the Prohibition of Riba and its Contemporary Interpretation. Leiden, Netherlands: E.J.Brill. Schoon, N. (2010). Islamic Banking and Finance. London: Spiramus Press Ltd. Warde, I. (2000). Islamic Finance In The Global Economy. Edinburgh: Edinburgh University Press. Read More