Islamic Banking

What is Islamic Banking INTRODUCTION This booklet aims to provide you some basic concepts and principles on Islamic banking.

Islamic banking Islamic banking is a banking activity which is consistent with the Islamic law (Shariah). Islamic banking is carried out in accordance with the rules of Shariah, known as fiqh muamalat (Islamic rules on transactions). It does not allow the paying and receiving of riba’ (interest) and promotes greater degree of fairness and equity in the conduct of banking business

The first Islamic bank was established in Malaysia in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS banks). The IBS banks are required to ensure that the funds and activities of the Islamic banking transactions are separated from the conventional banking business.

All licensed Islamic banks and IBS banks are required to display the Islamic banking logo as shown below:

SHARIAH PRINCIPLES IN ISLAMIC BANKING The rules and norms of fiqh muamalat emanated from two primary sources of Shariah namely the Quran and the Sunnah and other secondary and authoritative sources of Islamic law.

2 Islamic banking operates under a number of contracts under fiqh muamalat. Amongst the widely used concepts in Islamic banking include profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musyarakah), cost plus (Murabahah) and leasing (Ijarah).

SHARIAH COMMITTEE The Islamic banks and IBS banks must ensure that their operations comply with the principles of Shariah. Each institution is therefore required to set up a Shariah Committee to provide advice on Shariah issues and to ensure that its operations and activities comply with the Shariah principles. In addition, the Shariah Advisory Council set up at Bank Negara Malaysia (BNM) is the highest Shariah authority set up to provide advice on the Shariah matters pertaining to Islamic banking and takaful in Malaysia.

SHARIAH CONCEPTS IN ISLAMIC BANKING Wadiah (Safekeeping) For deposit product or Wadiah contract, a bank is the custodian and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of any part or the whole amount of the deposit when requested by the depositor. The depositor, at the bank's discretion, may be given 'hibah' (gift) as a form of appreciation for the use of funds by the bank. As a trustee of the items, the custodian may charge a fee to the customer.

Mudharabah (Profit Sharing) Mudharabah is a profit sharing arrangement or agreement between a capital provider and an entrepreneur. The entrepreneur is provided with funds by the capital provider to undertake a business activity. Any profits made will be shared between the capital provider and the entrepreneur according to the predetermined profit-sharing ratio. However, losses shall be borne by the capital provider.

3 Musyarakah (Joint Venture) This concept is normally applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio while losses incurred, will be divided based on the equity participation ratio. Murabahah (Cost Plus) The selling of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement.

Bai' Bithaman Ajil (Deferred Payment Sale) The selling of goods on a deferred payment basis at a price, which includes a profit margin agreed by both parties. Wakalah (Agency) This is the situation when a person appoints a representative or delegates a duty to another party to undertake transactions on his behalf. As an agent, the bank will be paid a fee for the services it provided. Qard (Interest-free Loan) A loan extended on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrower may, at his discretion, pay extra (without promising it) as a token of appreciation.

Ijarah Thumma Bai' (Hire Purchase) There are two contracts involved in this concept: Ijarah contract (leasing/renting) and Bai' contract (purchase). The contracts are undertaken one after the other. For example, in a car financing facility, a customer enters into the Ijarah contract to lease the car from the owner (financier) at an agreed rental for a specific period. When the leasing period ends, the Bai’ contract comes into effect, to enable the customer to purchase the car from the owner at an agreed price.

4 Hibah (Gift) A token given voluntarily in return for loan given or benefit obtained.

Frequently Asked Questions Q:

What is Islamic banking?

A:

This is a banking activity based on Islamic principles, which do not allow the paying and receiving of interest (riba’) and promotes profit sharing in the conduct of banking business.

Q:

Is Islamic banking meant for Muslims only?

A:

No. Islamic banking is for all individuals regardless of their religious belief.

Q:

What are the differences between Islamic and conventional banking?

A:

The most important difference between Islamic and conventional banking is the prohibition of interest in Islamic banking. Islamic banking activity must comply with Shariah principles and avoid prohibited activities such as gharar (excessive uncertainty). For example, instead of lending with interest, Islamic banks provide financing based on Bai’ Bithaman Ajil whereby it is based on trade.

Q:

How do Islamic banks and IBS reward their depositors since payment of interest is not allowed?

A:

Shariah allows the profit sharing arrangement between the bank and the depositor. Profits from Islamic banking activities will be shared between the bank and the depositor based on an agreed profit sharing ratio and paid in the form of dividends. The amount of dividend payout depends on the profits generated from the bank’s operation. Shariah also allows the bank to give hibah to its depositors based on its discretion.

Q:

Where can I obtain Islamic banking products and services?

5 A:

You can obtain Islamic banking products and services at any bank that carry the Islamic banking logo shown below:

For the latest update on the list of banks that offers Islamic banking products and services, please visit www.bnm.gov.my

Q:

Does the operations of the IBS banks fully comply with the requirements of Shariah?

A:

All Islamic banks and IBS banks are required to set up Shariah Committees to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. All products and services offered by the Islamic banks and IBS banks must be approved by their respective Shariah Committees.

Q:

Can an IBS bank transfer credit balances of a customer's Islamic account to a conventional account, or vice versa?

A:

Upon a customer's request, an IBS bank may transfer funds from an Islamic account to a conventional account. On the other hand, only the principal amount can be transferred from a conventional account to an Islamic account. No element of interest is allowed to be transferred.

Q:

What are the avenues available if I am dissatisfied with the services provided by Islamic banks or IBS banks?

A:

You should contact your bank if you have any complaints. All banks have set up a dedicated Complaint Unit to deal with customers’ complaints. Information on the contact person, telephone number and e-mail address is available on Bank Negara Malaysia’s website at www.bnm.gov.my.

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For more information on how to make a complaint, please read the booklet on “Making a Banking Complaint”.

7 Glossary Gharar An unknown fact or condition. An element which must be avoided in Islamic banking transactions since excessive gharar may render the contract null and void. Ibra’ Giving up of a right. In an Islamic banking transaction, a creditor gives up part or all of his right to a debtor usually for early settlement of the debt. Rahnu Making an asset as a security for a debt or a right of claim. Riba' The excess paid or received over and above the principal in a loan contract. Shariah The Islamic law which is derived from various sources – the Quran, the Hadith, the Sunnah, ijma’ (consensus of Muslim scholars), qiyas (analogy) and ijtihad (personal reasoning) of the Muslim jurists. It covers every aspect of life. Zakat The obligatory payment of a certain proportion of the wealth and each and every kind of property liable for zakat. This is paid annually for the benefit of eligible Muslims in the community. It is a major economic means for establishing social equity and leading the Muslim society to prosperity.