Islamic banking

Write an essay on “Islamic banking: as an alternative social and ethical banking”.
The issues to be addressed in the essay
1.  What is Islamic Banking?
2.  What is permissible under Islamic banking - halal vs haram. Rule of permissibility.
3.  Prohibitions under Islamic banking: Riba (Interest), Gharar( Excessive uncertainty or speculation), gambling.
4.  Western banking system vs Islamic Banking. Co-existence of western banks and Islamic banks
5.  Islamic banking products:
     Mudarabah (profit sharing, Musharakah (joint venture for fixed assets), Murabah (hire purchase of goods), Ijarah (leasing).
6.  Islamic Contracts: Wadia (property transfer for safe keeping, saving accounts): Hiwala (Debt transfer from one to another); Kafalah(guarantee or accepting another person's     debts); Rahn (pledge a property for collateral).
7.  Pricing Transactions in Islamic banking.
8.  Legality of Islamic banks: Authenticity of Shariah Boards.
9.  Current status of Islamic banks: Pakistan, Malaysia, UAE, UK.
10. Future of Islamic banking: problems and issues.

Introduction

Islamic banks operate in more than sixty countries particularly in Asia and Middle East countries. There are certain economic constraints in Islamic bank and thus it is necessary to determiner these different constraints that will help in improving the condition of the economies. Islamic banks are different from conventional banks. The most important feature of Islamic bank its profit and loss paradigm. Moreover, Islamic banks are not liable to offer a fixed rate of return. They do not have the power to charge any interest on loans (Ariss 2010). This paper will highlight the meaning of Islamic bank, the rules of permissibility under Islamic law, the prohibitions under Islamic banking. Further, it will also discuss the relationship between western banking system and Islamic banking system, the different contracts, the pricing transaction under this bank and legality of these banks. The problems and prospects highlighting the future of Islamic bank will also be analysed in this paper. 

Discussion

Islamic banks refer to financial institution that helps in mobilisation of the financial resources and to make considerable investments in them. This is necessary to achieve predetermined objectives that are considered financially and socially viable. The investments of funds as well as mobilisation of resources must be in accordance with the principles mentioned in Sharia. Islamic banks are growing in large number around the world in a short span of time. The practical application of Islamic banks is mostly in the Islamic economies.  In this type of economies, the risk bearing capacity lies upon the lenders of the particular venture or entity because the borrower is not responsible for the profit or loss of that particular entity. Under the profit and loss sharing paradigm, the fixed rate of return is prohibited and it is determined on the basis of profit sharing activities. The profit and loss making contracts allows the contracting parties to pool their individual resources and to share the profit and loss of the investors accordingly. This sharing ratio between the entrepreneurs i.e. the lenders and the capital provider i.e. the bankers are determined on the basis of ex-ante measures (Ariff 2017). 
The main aim of the Islamic banks was to establish the Shariah principles. The basic idea of these Shariah principle is to have the provision of Halal banking system and not to pay Riba(interest). It can be said that the main responsibility of these Islamic banks was to stay away from the conventional banks as well as foreign banks and to establish the Islamic principles in Islamic economies (Schoon 2016). The Islamic investors have a varied range of choices when they take an active role in the construction of portfolios. They include the bank deposits that are riba free and try to make investments in investment companies as well as Muslim business units in Islamic economies. This is done on the basis of halal banking system. Therefore, it can be said that if the banks operate according to the principles of Shariah and they do not deal with any terms and conditions i.e. considered to be haram, then they are permissible to be considered as Islamic banks. On the other hand, haram is prohibited under Islamic banks i.e. charging interest on loans (riba) that is done by the conventional banks. Thus, under Islamic banking system halal is permissible by the laws and principles of their Standing Committees (Iqbal and Molyneux 2016). 
Islamic banks prohibits Riba, Gharar and Maysir. Riba refers to unearned income and all forms of usuries that is restricted in Islamic religion. There are two categories of Riba i.e. riba-al-fadl and riba-al-nasi’ah. The former refers to the excess amount that is paid to fulfil the loan amount. On the other hand, riba-al-nasi’ah deals with interest on loans and this amount is basically fixed before granting a certain amount as loan. According to Islam religion, charging any amount of interest rate in lieu of loans granted to from business entities in times of needs are not considered to be any form of business in true form. There are certain fundamental differences between the profit that is earned by the business entities and the type of profit resulting from different interest charges (Basu, Prasad and Rodriguez 2015). There is no particular end point for interest based transactions and in some cases, it can be seen that the principle amount of the loan is not returned by the borrower properly. This case can be considered as unrepayable debts. On the other hand, the transactions that are based on interest consider no equitable division of profit between the lenders and the borrowers. Moreover, there is no fixed time in procurement of the goods in this type of transaction. The economic framework laid down by Islamic bank tries to promote the sharing of risk as well as reward that are considered conductive for promoting entrepreneurship as well as fulfilment of particular amount of debt. The loans that are taken must be interest free because the lenders do not know or they cannot predict whether it might yield profit or loss in the long run. Thus, these risk as well as reward must be shared between the lenders and the borrowers according to Islamic religion (Alam, Gupta  and Shanmugam 2017).
According to Islamic religion, Gharar refers to that type of transaction whose existence is not certain because of improper information or knowledge on that particular area. There is prohibition of all types of transactions in which involves injustice and exploitation to any parties in any form. The business and financial transactions in Islam must be based on accuracy and transparency. Moreover, the private information of the lenders or the borrowers must not be disclosed so that no two parties can take advantage of each other’s weakness. The main aim of Gharar is to provide a valid and proper satisfactory contract to both the parties. Moreover, appropriate consent must be taken from both the parties before exchanging or disclosing any forms of information between them. According to the principles of Shariah, information related to profit sharing or loss making between the lenders and the borrowers helps in promotion of brotherhood and thus, it will increases co-operation among them. If this is done, the risk associated with any form of transaction can be shared mutually between both the parties. This will encourage to share accurate and adequate information among the borrowers and the lenders and it will be easier for them to estimate the outcome of these relationship (Abdul-Rahman 2014). 
Moreover, Maysir is also considered to be a form of illegal transaction in gambling and it is against Islamic rules. In this form of transaction, wealth can be easily acquired from people and it does not consider the rights or the choices of the other parties. Although gambling is considered to be a form of speculation in Islamic religion and there should be no such operations that is considered to be speculative. Further, the speculation that is prohibited under Islamic religion requires a considerable portion of financial as well as economic data and a considerable amount of investment in skills and varied forms of assets. Maysir, thus involves gaining of wealth or assets through dishonest means and this is prohibited strictly in Islamic religion (Hanif 2014).
There are certain important differences between Islamic banks as well as western banks, although both the banking systems are considered to be closer to each other. The principle under Islamic banking system includes minimization of risk, risk sharing as well as avoidance of usury that are considered unethical and immoral. On the other hand, sharing of risk and profit under western banking system is considered to be a part of venture capital. There is provision of reverse lending process under western banking system. This type of investments is considered beneficial for in western banking system. In case of leasing under western banking, there is provision to buy a fixed number of assets at the pre-determined price and to make the equal number of payments in instalments. This payment of interest under the western banking system lays no impact on the residual value. Moreover, under Islamic banking money is considered as a measuring tool and profits from these kinds of tools are prohibited under Islamic banking. In case of leasing under this banking system, it is the responsibility of the lessor must try to purchase the assets during the lease period. It is the responsibility of the lessor to make payment and to bring the asset to a particular agreed value. However, there is co-existence between Islamic banks as well as western banks. The investors try to invest in both public as well as private equities. Moreover, the companies that invest in alcohol, gambling or tobacco products are permissible under western banking system. The organisation that exceeds the limit on interest bearing debt is also prohibited to make investments under the Islamic banking system. The financers under western banking system are open to certain modifications and the Islamic investors tries to provide a considerable sum to open up to greater opportunities and to invest in varied range of products and services that are permissible under Sharia rules (Kammer et al.2015). 
There are several banking products under Islamic banking and it includes Mudarabah, Musharakah, Murabah and Ijarah. Mudarabah involves a contractual relationship between capital supplier and the agent that supplies labour. These helps in making investments in certain pre-determined activities and the share of each party is set before making the investment. Mudarabah involves two types of business transaction i.e. restricted, when the capital provider provides specification for any particular business to invest the capital. The other includes unrestricted where the provider specific any other individual to invest on his behalf. Murabaha includes bilateral agreement on profits associated with any transaction. Here, the seller sets his costs and profits and this is acceptable by the Islamic religion as a better and developed technique in making transactions. Musharakah helps in division of profit and loss between the two parties involved in the agreement. Here, the Islamic bank delivers the necessary capital and this is joined with investments on the other side. The contracting parties have the power to invest in the activities of the management. On the other hand, Ijara involves the right to sell for a certain period or for lifetime for receiving reward in return. This can be considered as a service equivalent to hire or rent. It is generally used in case of a piece of land for receiving a fixed amount of rent (Khir, Gupta and Shanmugam 2007). 
According to Wadiah, banks are considered to be trustee as well as a protector for depositing a sum of money. Everyone can deposit money in bank without any fear of loss and can withdraw it according to his requirements. Hiwala includes transferring the rights of one individual to another. It can be considered as a binding contract where both the parties will have to agree for a particular termination in order to make it effective. Kafalah involves contracts associated with guarantee and this is not applicable in case of any adverse changes that lead to irregular outcomes. Both the importer and the exporter will be assured that they will receive the due that is agreed at the initial stage. On the other hand, in case of Rahn, there might be certain collateral and this can be layed off or ignored in times of default. It is vital to agree to the rules and procedures of the debtors and there must be no such assets left for possession of the creditors. 
Since a long time, there has been continuous debate on the benchmarking practice that is followed by the Islamic banks is in accordance with the London Interbank Offered rate(LIBOR). There has been no clear difference between Shariah banking system and LIBOR that are considered to be determinants of return. Moreover, this process of benchmarking is associated with the process of integrity and there are certain challenges associated with these concepts. The amount of profit derived from different financial assets is determined in accordance to the particular rate of return.  Moreover, the relation between these profit as well as real sector is positively associated with each other and these are considered to be equilibrium factors in the monetary system. 
Islamic banks are authentic because there are certain equitable perspectives as well as ethical issues that are associated with this bank.  Moreover, there is flexibility in this kind of banking structure because it is based on sharing of profit and loss mechanism. There is also provision for unleashing the potentials which are considered important in case of financial innovations of Islamic banks. There is also a wide range for diversification of assets and proper governance by the Shariah board that is necessary for the investment account holders. It is also vital to understand the risk and other frameworks that help in facilitation of Islamic products and thus make it easier to understand Islamic finance (Karbhari, Naser and Shahin 2004).
There has been growth in the market share of Islamic Bank in Malaysia by 1.2% in 2016 over the past four years. Its share in the global market is 15.5% in 2014 and the return on assets is also found to be increasing since the past few years. On the other hand in UAE, there was no such considerable increase over the past few years. However, there has been growth in the global market and also a steep growth in the banking assets in UAE. The Islamic banks in Pakistan continue to grow at the rate of 10% and this has led to the increase in the market share. It is expected to grow at the rate of 15% in the next few years.  United Kingdom has the highest number of Islamic banks than any other western countries. Moreover, these institutions are functioning properly in UK since 2003 due to the removal of tax barriers from different types of Islamic banking products (ey.com 2018). 
Islamic banks are expanding and they will continue to expand over the years across different countries in the world. These banking institutions will survive due to its economic viability, responding to the challenges as well as maintaining proper stability. It has also increased the confidence of the investors and thus will lead to its growth in the long run. The restriction of Riba will remove the liquidity problem of the customers. Moreover, the flow of funds in the Islamic banks will be in accordance with the real economic activities. 
 
                      Fig- Future projections of Islamic banks
                               Source-www.ey.com
On the basis of the above projections, it can be said that key players in future based upon banking assets as well as annual growth rate includes Saudi Arabia, Pakistan, Qatar , Turkey and UAE. This bank will also improve its market share by 2020 (ey.com 2018).

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Conclusion

Therefore, it can be said that Islamic banks differ from western banks and this is because of the profit and loss sharing paradigm. There is only a small proportion of finance that is dependent on profit loss framework in the asset side of Islamic banks. On the other hand, in liability side only a small proportion is in accordance with the Islamic rules and laws. Thus, the adoption of profit and loss framework is affected only through competition with the conventional banks. 

References 

Abdul-Rahman, Y., 2014. The Art of RF (Riba-Free) Islamic Banking and Finance: Tools and Techniques for Community-Based Banking. John Wiley & Sons.
Alam, N., Gupta, L. and Shanmugam, B., 2017. Comparative Analysis: Islamic Banking Products and Services in Different Countries. In Islamic Finance (pp. 245-305). Palgrave Macmillan, Cham.
Ariff, M., 2017. Islamic Banking in Malaysia: The Changing Landscape. Institutions and Economies, pp.1-13.
Ariss, R.T., 2010. Competitive conditions in Islamic and conventional banking: A global perspective. Review of Financial Economics, 19(3), pp.101-108.
Basu, M.R., Prasad, A. and Rodriguez, M.S.L., 2015. Monetary Operations and Islamic Banking in the GCC: Challenges and Options. International Monetary Fund.
ey.com 2018. [online] Available at: http://www.ey.com/Publication/vwLUAssets/ey-world-islamic-banking-competitiveness-report-2016/%24FILE/ey-world-islamic-banking-competitiveness-report-2016.pdf [Accessed 22 Feb. 2018].
Hanif, M., 2014. Differences and similarities in Islamic and conventional banking.
Iqbal, M. and Molyneux, P., 2016. Thirty years of Islamic banking: History, performance and prospects. Springer.
Kammer, M.A., Norat, M.M., Pinon, M.M., Prasad, A., Towe, M.C.M. and Zeidane, M.Z., 2015. Islamic finance: Opportunities, challenges, and policy options (No. 15). International Monetary Fund.
Karbhari, Y., Naser, K. and Shahin, Z., 2004. Problems and challenges facing the Islamic banking system in the west: The case of the UK. Thunderbird International Business Review, 46(5), pp.521-543.
Khir, K., Gupta, L. and Shanmugam, B., 2007. Islamic banking: A practical perspective. Institut Bank-Bank Malaysia.
Schoon, N., 2016. Modern Islamic banking: products and processes in practice. John Wiley & Sons.

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