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Economy and Finance

Economy and Finance

ISLAMIC BANKING

16 Feb 2024 Zinkpot 226
  1. Islamic banking is a financial system that operates following Islamic law, known as Shariah, which prohibits the payment or receipt of interest (riba). 
  2. Instead of traditional interest-based lending, Islamic banking relies on profit-sharing arrangements, risk-sharing, and ethical investment principles.
  3. Key principles of Islamic banking:
    • Prohibition of Riba (Interest): Islamic finance strictly prohibits the payment or receipt of interest. Transactions must be free from any predetermined interest charges.
    • Profit-and-loss Sharing (Mudarabah and Musharakah): Islamic banks engage in profit-and-loss sharing arrangements with their clients. Mudarabah involves one party providing capital, while the other provides expertise and management, with profits shared according to a pre-agreed ratio. Musharakah involves joint participation in a business venture, with profits and losses shared proportionally.
    • Fiqh al-Muamalat: The rules governing commercial transactions in Islamic banking are referred to as Fiqh al-Muamalat. Employees of Islamic institutions adhere to these principles while conducting business.
    • Asset-Backed Financing: Islamic finance encourages financing based on tangible assets or services. This ensures that money is linked to real economic activity and discourages speculative transactions.
    • Avoidance of Uncertainty and Speculation (Gharar): Islamic finance discourages excessive uncertainty and speculative transactions. Contracts must be clear and transparent to avoid ambiguity and unfair practices.
    • Ethical and Social Responsibility: Islamic banks are expected to adhere to ethical and socially responsible principles. Investments in businesses involving activities such as gambling, alcohol, and pork are typically avoided.
    • Islamic Bonds (Sukuk): Instead of conventional bonds, Islamic finance uses Sukuk, which represents ownership in a tangible asset. Sukuk holders receive a share of the profits generated by the underlying asset.
    • Islamic Insurance (Takaful): Takaful is an Islamic alternative to conventional insurance, where participants contribute to a fund that provides coverage against specified risks. The concept is based on cooperation and shared responsibility.
  4. Islamic banking has grown globally, with Islamic financial institutions offering a range of products and services. Countries with predominantly Muslim populations, as well as non-Muslim-majority countries, have witnessed the establishment and growth of Islamic banks and financial institutions. This growth reflects the demand for financial services that align with Islamic principles. 
  5. Over 560 banks and more than 1,900 mutual funds worldwide comply with Islamic principles. Between 2015 and 2021, Islamic financial assets grew from $2.17 trillion to approximately $4 trillion and are projected to reach around $5.9 trillion by 2026.
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