Islamic Banking is defined as the banking system that is based on the principles of Islamic law (also known Shariah) and is guided by Islamic economics. The two basic principles behind Islamic banking are :
- The sharing of profit and loss
- Prohibition of the collection and payment of interest.
Islamic banking has been defined as banking in accordance with the philosophy and the value system of Islam. This type of banking’s concept is not use any instruments which consist of interest. Islamic banking, the more general term is expected not only to avoid interest-based transactions prohibited in the Islamic Shariah but also to avoid any unethical practices . However Islamic Shariah prohibits ‘interest’ but it does not prohibit all gains on capital.
This system is based on risk-sharing, owning and handling of physical goods, involvement in the process of trading, leasing and construction contracts using various Islamic modes of finance. As such, islamic banks deal with asset management for the purpose of income generation. They will have to carefully handle the unique risks involved in management of assets by complying to best practices of corporate governance.
If we further look at the roots of Islamic banking we discover that during the early days of islam the businesses which were there were joint ventures based on sharing of risks & profits and provision of services through trading, both cash and credit, and leasing activities. In the Verse II:275, Allah the Almighty did not deny the apparent similarity between trade profit in credit sale and Riba in loaning, but resolutely informed that Allah has permitted trade and prohibited Riba.
While Profit has been recognized as ‘reward’ for (use of) capital and Islam permits gainful deployment of surplus resources for enhancement of their value. However, along with the entitlement of profit, the liability of risk of loss on capital rests with the capital itself; no other factor can be made to bear the burden of the risk of loss.
ISLAMIC BANKING IN PAKISTAN
Pakistan was founded and made for implementing Islamic rules and laws in an independent country. All religious circles and groups were constantly demanding for elimination of Riba from the financial and banking system of Pakistan as the constitutions of the country had already included the elimination of riba as early as possible because the laying foundation of Pakistan is to follow the rules and laws as mentioned in Quran and Sunnah.
As a result Islamic Banking was introduced in 1980 in Pakistan and it became role model for all muslim countries. Eventually many private Islamic banks emerged as well as conventional banks also started facilitating Islamic Products such as Musharika, Mudariba, Murabaha and Ijara etc. and many other schemes for Depositors and borrowers.
Presently all Conventional and Private Banks are providing services of Islamic Banking but currently there are only three large private banks which are purely operating as per Islamic rules under the supervision and guidelines of Shariah Board established by famous Muftees of a leading Islamic Institution. As per Shariah requirements, the funds and products of Islamic Banking are being managed separately from the conventional banks. It is experienced that the business of those businessmen expanded who did the borrowing according to Islamic laws and got rid of riba from their activities.
Islam is not just a religion. It is a complete political, social, financial and an economic system. The principles of Islam are completely guided in the Holy Quran which are explained by Hadith and physically practiced by Holy Prophet Hazrat Muhammad (P.B.U.H.).
The Islamic Economy System is based on the following principles:-
- All wealth belongs to Almighty Allah and Man is the trusty of Wealth.
- Wealth must be in circulation and holding of wealth is restricted.
Conventional economy creates a phenomena of distribution wealth un justly as it is originated by man-made laws and system. Islamic economy eliminates the monopoly of an Individual, Group or Organization to keep control on World monitory policies and avail most of the resources by blocking wealth. It also protects the society and secure the needs of the people.Basic principle of Islam Banking is to prohibit in riba based financing, lending and in sales. Interest is restricted and the owner of funds becomes Investor instead of Creditor. The Investor and Entrepreneur shares the business on risk ,profit and loss according to the ratio of investment and participation according to their Capital and Skill/Performance.
DEFINITION OF INTEREST
When money becomes a commodity and bought and sold with guaranteed results of profitability on increase in volume of money being used for transaction. Such increase is the price of money and this is classified as Interest, which is the part of Riba. Any amount, earning or income that is taken over above the principle amount without any risk, effort, activity without loss sharing within a specific time is called Interest.
DEFINITION OF PROFIT
Income on financing is determined not on financing amount, cost of transactions and applicable free and charges as a part. Profit is the aim of financing and loss is acceptable.
Operational differences in Conventional Banking and Islamic Banking is as follows:-