Question

Report on the evolution, function and the essence of Islamic banks and financial institutions.

Answer 1

. Today, the Islamic banking system has emerged as a competitive and viable substitute for the traditional, existing banking system. Pakistan and Malasia are examples of the countries that have in place an Islamic banking system. Under this system, earning money in the form of interest is prohibited. It complies with the Sharia (Islamic Law).

Evolution

Islamic finance has roots in the past, but there has been a resurgence in the past 30 years. The first Islamic bank was brought into existence in Egypt in 1963. Its fundamental principle was profit sharing. By the end of the next decade, this was so popular that there were 9 such banks in the country itself. These banks neither charged nor paid interest and kept their activities mostly limited to trade. So, these banks were working more like a financial institution rather than a commercial bank. In the 70s many more banks came into existence in different parts of the world. In the 80s, the scope of Islamic finance became wider since it now covered in addition to banking activities, the capital markets, and other financial instruments. Then the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was formed to advise and bring uniformity on Islamic finance standards all over the world.

The functions of the Islamic Banks are:

(1) The primary function of the Islamic Banks are acceptance of deposits from savers on a profit and loss basis and lend money to individuals/business units in requirement of funds on a profit and loss basis. So unlike a conventional Bank, there is no concept of interest, rather the business is encouraged to succeed and only a share in the profit is taken by the bank.

(2) It accepts deposits so as to invest it in various profitable ventures. The bank here acts as an agent. They then share the profits (or losses) from the venture. This way the depositor makes an income.

(3) This system also allows for the opening of current accounts, but the difference is that here instead of any interest the bank charges a fee.

(4) Islamic banks today provide services like collection of cheques, collection of dividends and purchase/sale of securities. It also performs other services such as collection of utility bills, foreign exchange remittances.

Essence / Key Principles of Islamic Banks and Financial Institutions.

The Islamic finance is based on the following fundamentals;

(1) Prohibition of Interest or RIBA.

Since RIBA is considered haram or as an unfair award to the provider of funds for no underlying risk taken, it is prohibited.

(2) Prohibition of Uncertainty & Speculation.

All financial transactions undertaken are to be free from Uncertainty & Speculation ( Activities that resemble gambling)

(3) Prohibition of forbidden Assets

Finance is not to be provided for any activity not allowed as per Islamic Laws.

(4) Profit and risk-sharing.

SInce RIBA is prohibited, this kind of finance promotes a just, fair and balanced society. The banks instead of charging interest share the profits or risk.