Definition of Islamic banking

What is Islamic banking?

Islamic banking, also known as Islamic finance or Sharia compliant finance, refers to financial activities that adhere to Sharia (Islamic law). Two fundamental principles of Islamic banking are profit and loss sharing and the prohibition of the collection and payment of interest by lenders and investors.

Understanding Islamic banking

There are around 520 banks and 1,700 mutual funds around the world that follow Islamic principles. Between 2012 and 2019, Islamic financial assets grew from $ 1.7 trillion to $ 2.8 trillion and are expected to reach nearly $ 3.7 trillion by 2024, according to a 2020 report by the Islamic Society for Private Sector Development (DCI) and Refinitiv. This growth is largely due to the economic growth of Muslim countries (especially those that have benefited from the rise in the price of oil).

Islamic banking is founded on the principles of the Islamic faith with regard to business transactions. The principles of Islamic banking are derived from the Koran, the central religious text of Islam. In Islamic banking, all transactions must comply with Sharia, the legal code of Islam (based on the teachings of the Quran). The rules that govern business transactions in Islamic banking are called fiqh al-muamalat.

Employees of institutions that respect Islamic banking are instructed not to deviate from the core principles of the Quran while doing business. When more information or advice is needed, Islamic bankers turn to learned scholars or use independent reasoning based on scholarship and customary practices.

One of the main differences between conventional banking systems and Islamic banking is that Islamic banking prohibits wear and speculation. Sharia law strictly prohibits any form of speculation or gambling, which is called butir. Sharia law also prohibits charging interest on loans. In addition, any investment involving items or substances prohibited in the Quran, including alcohol, gambling, pork, is also prohibited. In this way, Islamic banking can be seen as a culturally distinct form of ethical investing.

To earn money without the usual practice of charging interest, Islamic banks use equity participation systems. Equity participation means that if a bank lends money to a business, the business will repay the loan without interest, but instead gives the bank a share of its profits. If the business defaults or does not make a profit, the bank does not profit either. In general, Islamic banking institutions tend to be more careful in their investment practices. As a result, they generally avoid business that could be associated with economic bubbles.

History of Islamic banking

Islamic banking practices generally date back to Middle Eastern businessmen who began to engage in financial transactions with their European counterparts in medieval times. At first, they used the same financial principles as the Europeans. However, over time, as trading systems developed and European countries began to establish local branches of their banks in the Middle East, some of these banks adopted the local customs of the region where they were newly established. established, mostly interest-free financial systems that operated on a profit and loss sharing method. By adopting these practices, these European banks could also meet the needs of local businessmen who were Muslim.

From the 1960s, Islamic banking resurfaced in the modern world, and since 1975 many new interest-free banks have opened. While the majority of these institutions were founded in Muslim countries, Islamic banks also opened in Western Europe in the early 1980s. In addition, national interest-free banking systems were developed by the governments of Iran, Sudan. and (to a lesser extent) Pakistani.

Islamic bank example

The Mit-Ghamr Savings Bank, established in 1963 in Egypt, is widely regarded as the first example of Islamic banking in the modern world. When Mit Ghamr loaned money to businesses, he did so on a profit sharing model. The Mit-Ghamr project was closed in 1967 for political reasons but during its year of operation the bank was very cautious, approving only about 40% of its applications for business loans. . However, in times of economic prosperity, the bank’s default rate was considered zero.