Sharia Banking and Finance: A Comprehensive Overview

Sharia banking is a type of banking that adheres to Islamic principles and guidelines. It's based on the concept of risk-sharing and prohibits the collection and payment of interest.

Sharia banking prohibits the collection and payment of interest, known as riba, which is considered exploitative and unfair. This means that Sharia banks cannot offer loans with interest rates.

In Sharia banking, transactions are based on mutual agreement and risk-sharing, rather than lending and borrowing. This approach encourages economic growth and stability.

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Islamic banking is grounded in the Quran and the teachings of the Islamic faith. The principles of Islamic banking are derived from the Quran, the central religious text of Islam.

All transactions in Islamic banking must comply with Shariah, the legal code of Islam based on the Quran. Shariah rules govern commercial transactions in Islamic banking and are referred to as fiqh al-muamalat.

In Islamic banking, interest is forbidden, and uncertainty, excessive risk, and speculation are also not allowed. This means that Islamic banks do not include interest in any of their transactions.

Financing is provided in exchange for a good or service, and the money is paid to the seller against the invoice instead of the customer.

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Islamic banking offers various types of lending and contracts that adhere to Shariah principles. Mudarabah is a profit-sharing model where the bank acts as the capital partner and the depositor and entrepreneur share profits. However, in practice, fixed-return models like murabaha have become the industry staples.

The murabaha model, also known as mark-up, is a type of credit sale where the bank buys an item and sells it to the customer at a higher price. This model is similar to interest-based finance and has become the most common mode of Islamic financing. Critics argue that it is not Shariah-compliant and is merely a way of charging interest under a different name.

Other types of contracts include Rahn, which is a collateral or pledge contract, and Qardh-ul Hasan, a benevolent loan that is interest-free and extended to needy people. Rahn is used to secure a financial liability, while Qardh-ul Hasan is often made by social service agencies or firms as a benefit to their employees.

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Here are some common types of Islamic contracts:

Islamic lending is a unique and complex field, with various types of contracts and arrangements. One of the most common types of lending is Murabaha, a form of credit sales where the lender buys a commodity and sells it to the borrower at a markup.

In Islamic banking, Tawarruq is another type of lending that involves buying and selling commodities to raise cash. This contract is often used to finance large projects, but critics argue that it can be abused and lead to widespread exploitation.

Taqi Usmani explains that paying more for credit when buying a product does not violate Sharia law, but exchanging one unit of money for another of the same denomination does. This is why Islamic lenders often use contracts like Murabaha and Tawarruq, which involve the exchange of commodities for money.

There are several types of Islamic lending contracts, each with its own unique characteristics and requirements. Here are some of the most common types:

Each of these contracts has its own set of rules and requirements, and Islamic lenders must carefully consider these factors when determining which type of contract to use. By understanding the different types of Islamic lending contracts, borrowers and lenders can make informed decisions and ensure that their transactions are compliant with Sharia law.

Hawala is a widely used, informal value transfer system based on a network of money brokers, known as Hawaladars, throughout the Muslim world.

Hawala is not an alternative to conventional banking transfers, as electronic wire transfers are not considered un-Islamic, but it has the advantage of being available in places where wire transfers are not.

Hawaladars are often small traders who work at hawala as a sideline or moonlighting operation.

Hawala networks are usually family or clan-based, which helps enforce the contracts.

Recipients of funds often identify themselves with passwords given to them by the senders.

Hawala predates conventional banking remittance systems by many centuries, with Dubai serving as a traditional hub.

The hawala system is based on a short-term, discountable, negotiable promissory note called a Hundi, which is transferred from one debtor to another.

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Wakalah is a type of contract where a person appoints a representative to undertake transactions on their behalf, similar to a power of attorney agreement.

This representative, known as the agent or wakil, is responsible for carrying out tasks such as selling and buying, lending and borrowing, and making payments.

Wakalah contracts are non-binding and are typically used for a fixed fee.

The agent's services can also include debt assignment, guarantee, gifting, and litigation.

In a Wakalah contract, the principal or muwakkel delegates their authority to the agent, who then acts on their behalf.

An example of Wakalah can be seen in a mudarabah profit and loss sharing contract, where the mudarib serves as a wakil for the rabb-ul-mal.

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Islamic banks offer various types of deposit and investment accounts that cater to different needs and preferences.

In Islamic banking, depositors can hold "Investment accounts" that are based on profit and loss sharing and asset-backed finance, similar to conventional time deposits. These accounts have a fixed term and offer an expected profit rate instead of interest.

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Islamic banks also offer "Demand deposits" that provide no return and are structured with qard al-hasana contracts or wadiah or amanah contracts. This type of account is convenient for depositors who need to access their funds on demand.

Here are some key differences between restricted and unrestricted investment accounts:

Islamic banks offer deposit accounts that are similar to time deposits, but with a twist. They're called "Investment accounts" and are based on profit and loss sharing and asset-backed finance.

These accounts are designed to be held for a fixed amount of time, just like traditional time deposits. However, the return on investment is measured as an "expected profit rate" rather than interest, as seen with Al Rayan Bank in the United Kingdom, which offers "Fixed Term" deposits or savings accounts.

Demand deposits, on the other hand, provide no return and are structured with qard al-hasana contracts or wadiah or amanah contracts.

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Islamic banks pool all types of deposits, which goes against the original proponents' calls for keeping distinct accounts for various types of deposits.

Here are some key differences between Islamic and traditional deposit accounts:

In Islamic banking, there are two main types of investment accounts offered by Islamic banks for those investing specifically in profit and loss sharing modes – restricted or unrestricted.

Restricted investment accounts (RIA) enable customers to specify the investment mandate and the underlying assets that their funds may be invested in. This level of control is not available in unrestricted investment accounts (UIAs).

In Malaysia, which has a strong Islamic banking sector, these two types of investment accounts are offered by Islamic banks. Some have complained that UIA accounts lack transparency and fail to follow Islamic banking standards.

UIAs are not guaranteed against losses, but they may be "tailored to meet a diverse range of customer needs and preferences". This flexibility comes with a trade-off, as customers have less control over how their funds are invested.

Here are the key differences between RIA and UIA:

Restricted investment accounts offer customers more control and transparency, but may be less flexible. Unrestricted investment accounts, on the other hand, offer flexibility and customization, but may lack transparency and accountability.