Frequently Asked Questions on Islamic Banking

1. THE HOLY QUR’ANHAS PROHIBITED RIBA. WHAT IS MEANT BY THIS TERM?

The term Riba can be loosely translated into the financial concept of ‘interest’.  As per Shariah law and Islamic scriptures, the practice of giving or taking interest upon principal is prohibited.  In financial transactions a few types of Riba could arise, namely, riba al-qard, riba al-nasa or riba al-Quran.  It so happens in Islamic societies that traders and bankers tend to circumvent explicit payment of interest through other subtler means.  Taking congnisance of this loophole, Islamic scholars have identified ribas such as riba al-fadl and riba al-buyu, so that the faithful would be forewarned of forbidden commercial practices.

2. WHAT IS THE SCOPE OF TRANSACTIONS TO WHICH THE BAN ON RIBA IS APPLICABLE? DOES THE TERM APPLY ONLY TO THE INTEREST CHARGED ON CONSUMPTION LOANS OR DOES IT ALSO COVER PRODUCTIVE LOANS ADVANCED BY BANKING AND FINANCIAL INSTITUTIONS?

The Shariah clearly states that riba al-nasi’ah, “the fixing in advance a positive return on a loan as a reward for waiting” is prohibited.  Hence it could be understood as a ban on interest as commonly used today.  Islamic jurists, the fuqaha, state in no unclear terms that all manifestations of riba are forbidden.  So it does not matter if the context is consumption or business and also whether the loan in issued or availed.  It is also irrelevant whether the institution in question is a commercial bank, government agency, business enterprise or an individual.

3. DOES THE PROHIBITION OF RIBA APPLY EQUALLY TO THE LOANS OBTAINED FROM OR EXTENDED TO MUSLIMS AS WELL AS NON-MUSLIMS?

The Islamic Fiqh Academy (IFA), which is the leading authority on financial transactions, mentions that there is no leniency in the application of Shariah laws even if one party of a financial transaction is non-Muslim.  In other words, if either the issuer or receiver of a payment is non-Muslim, the forbidden forms of ribas discussed above would still remain prohibited.  This clarification is made in resolution no. 10/2 of the IFA.

4. THE VALUE OF PAPER CURRENCY DEPRECIATES IN INFLATIONARY SITUATIONS. IN ORDER TO COMPENSATE   LENDERS FOR THE EROSION IN THE VALUE OF THEIR PRINCIPAL, A SCHEME OF “INDEXATION” HAS BEEN    SUGGESTED. IS SUCH A SCHEME ACCEPTABLE FROM AN ISLAMIC POINT OF VIEW?

In economies with high rates of inflation, restrictions imposed by Shariah laws can undermine value of investments.  To compensate for such a loss, a method of indexation is usually employed.  There is no consensus yet among the fuqaha, as to the compatibility of indexation practices with Islamic scriptures.   So far the Fiqh Academy has permitted indexation in cases pertaining to “wages and contracts fulfilled over a period of time” and has disallowed in cases pertaining to monetary debts.  Similarly, “for debts in a specific currency, due in installments, the parties may agree to settle the installments due in a different currency at the prevailing rate of exchange on the date of settlement”.

5. WHAT ARE THE MAJOR MODES OF FINANCING USED BY ISLAMIC BANKS AND FINANCIAL INSTITUTIONS?

Islamic banking system has invented a few ingenious modes of financing in order to comply with Shariah principles.  The first mode is based upon sharing of both profits and losses incurred by investments, respectively the mudarahab (passive partnership) and musharakah (active partnership).  The second mode operates on the basis of credit offered durig the purchase of goods and services and uses such financial concepts as murabahah (sales contract at a profit markup), ijarah (leasing), salam and istisna (contracts).  These modes are unique to Islamic finance and have been approved by fiqh officials.  Apart from being consistent with Islamic precepts, these modes incentivise direct investments, thereby contributing to economic growth of the bank/institution/country.  Yet, improvements need to be done in order to integrate Islamic financial system into global economy.

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