O ye who believe! Fear Allah and give up what remains of your demand for Reba, if ye are indeed believers And if you do not, then take notice of war from Allah and His Messenger. But if you repent, you shall have your capital (Deal not unjustly, and you shall not be dealt with unjustly [al-Baqarah 2:278-279]
Islamic Banking Principles
Islamic Banking is simply a banking structure and activity, which operates in compliance with Islamic law or Sharia principles. Islamic banks offer Islamic banking products and services that are governed by the Islamic rules on transactions or Fiqh al-Muamalat. Said rules:
- Prohibit dealing in any form of interest or Reba, whether paying or receiving.
- Forbid investing in businesses that are deemed as unlawful or Haram, such as businesses that trade in alcohol, pork, weapons, or promote unethical, immoral or non-Islamic values.
- Ban trading in any type of activity that entails concealed flaws or Bayh Al-Gharar, as it is considered a form of gambling.
- Set Profit & Loss Sharing and Risk Sharing as the basic principles guiding Islamic banks transactions.
The Role of Islamic Banking
Islamic banking was created to care and invest on the communities that it serves.
Islamic banking seeks to promote the ideal of prosperous society and stable economy, based on the Islamic ideology of social fairness, ethics and sympathy.
Islamic banking challenges the concept of inequality in offering banking services to people of different social standings and attempts for social harmony between different classes.
Yet, Islamic banking is a commercially viable way of banking, which offers an alternative financial architecture on economic grounds.
Evolution of Islamic Banking
Modern Islamic banking practices can be tracked hundred of years back to the days of Prophet Mohamad (PBUH) himself. At that time, the Prophet acted as a mudarib or agent for his wife Khadiga who entrusted him with a certain capital or goods for trade. Afterwards, the Prophet (PBUH) reimbursed the capital and the profit was shared between the two parties.
Throughout the years, Muslim bankers and religious scholars struggled to devise financial instruments that integrate Islamic values with banking activities. Though profit was important, nevertheless, said instruments were needed to promote ethical and transparent financing, equitable distribution of wealth, and equity participation in the economy.
In the late 50s, the first efforts to create an Islamic financing environment emerged in Pakistan. Nevertheless, modern Islamic banking first appeared, on a small scale, in Egypt early in the 60s. Following the oil boom in the 70s, Islamic banking flourished in the Arab world, and then spread out into the Middle East, Iran, and Southeast Asia. In the mid 70s, the world's first full-fledged Islamic bank was established in UAE.
Because of its ethical and moral principles, Islamic banking has gradually succeeded in achieving universal acceptance and attracted funds from both Muslims and non-Muslims alike.
Currently, more than 300 Islamic banks are present on the five continents of the world, operating in more than 60 different countries such as the UK, the US, France, Germany, Denmark, Luxembourg, Switzerland, the Bahamas, Cyprus, Pakistan, India, and of course the Arab world.
With an annual growth rate of 15% to 20%, Islamic banks assets exceeded $ 500 billion by end of 2007. Islamic banking is maintaining its impressive growth worldwide, yet at a faster pace than conventional banking, to become an actual globalization phenomenon.
Islamic banking was introduced to the Lebanese market in the early 90s under a commercial banking license. All transactions strived to offer conventional banking products and services in compliance with Sharia based on two regulations.
1-Fiduciary contracts law.
2-Investment banking general directives.
It was not before 2004 that Islamic banks were authorized in Lebanon. Under a law no. 575 dated 11 February 2004, supplemented by two circulars dated 30 August 2004, in which the Central Bank of Lebanon set the regulatory framework for Islamic banking in Lebanon.
In 2005, The Lebanese Islamic Bank S.A.L., member of the Credit Libanais group, became the first licensed Islamic bank in Lebanon.
We strongly believe that once marketed and implemented as a system, instead of being approached as a product to be offered to a niche market, Islamic banking will prosper and fulfill its mission.
A Sharia advisory committee/board is a prerequisite for any bank offering Islamic banking products and services. The Sharia board should be appointed to approve and provide advice on bank's operations, and supervise its activities to ensure that they permanently comply with Sharia principles. The members of the board should comprise renowned religious scholars with profound knowledge and experience in Fiqh al-Muamalat and Sharia laws relating to finance. (LIB Sharia Board click to see)
Islamic Banking Instruments
Since its creation, Islamic banking strived to offer adequate and effective Sharia compliant alternatives to conventional banking products and services. For that purpose, it has created and adopted several financing instruments and contracts, most of which are asset-backed.
Murabaha is considered the most popular tool used in Islamic banking. Murabaha is a sale of goods contract between the bank and the client. In this transaction, the client has to first select the goods of his choice to be financed. Bank will purchase the goods, add an agreed upon profit margin, and then deliver the goods to the client. In his turn, the client will reimburse the original cost, plus the bank's profit margin, over prearranged installments.
Murabaha contract is valid only if original cost, other costs, profit margin, selling price are transparent to the client and clearly stated in the Murabaha agreement.
Murabaha is widely used in corporate banking for trade finance, mainly purchases from suppliers in form of wire transfers, CADs, Letters of credit and Letters of guarantee. It is also the common mode of Islamic financing of retail and consumer goods.
Musharaka is establishing a partnership or joint venture between the bank and the client for a specific business or project. It is a profit and loss sharing financing agreement, in which the bank and the client will both contribute their capital and expertise in the partnership.
Profit distribution will be allocated according to an agreed upon ratio. In case of losses, both parties will share the losses on the basis of their equity participation.
Musharaka can take two forms:
1-Fixed Musharaka for a predetermined period. This Musharaka will remain valid till its termination date, agreed upon at initiation date. Nevertheless, and for any reason, any of the shareholders can sell his share of capital and eventually exit the Musharaka.
2-Diminishing Musharaka ending with full ownership. This type of Musharaka is considered among the latest innovations created by Islamic banks. It differs from Fixed Musharaka only in terms of continuity, as the banks share will gradually decrease with client installments, till client gets full ownership of the project assets.
Musharaka can be used both for short term and for long term financing, from residential house purchase to funding capital projects.
As in Musharaka financing, Mudaraba takes the form of a partnership or joint venture between the bank or investor (Rabbul Mal), and the client or entrepreneur (Mudarib) for a specific business or project. The main difference is that the bank will provide the capital and the client will provide management, expertise and know-how.
Profit distribution will be allocated according to a pre-agreed ratio. Nevertheless, only the bank bears any losses if occurred.
Mudaraba contract remains valid till original capital is fully redeemed, unless otherwise specified in the contract.
Mudaraba is typically used for long-term transactions of substantial size.
Istisnaa is an order sale contract between the bank and the client, mainly to finance a certain product/asset, to be developed and delivered at a pre-determined future time, at an agreed price. Normally, bank will disburse funds according to the stage of completion.
The bank hardly ever orders the product/asset for its own use; as such the bank will generally re-sell the product/asset to the client at a predetermined price, which includes the bank's profit. In return, the client reimburses the total amount over agreed upon monthly installments.
Istisnaa is generally used for financing housing projects, construction of industrial and commercial buildings such as warehouses, showrooms, shopping malls, and so on.
Ijara is the most flexible and practical financing tool allowing individuals and businesses to acquire highly expensive or technologically advanced assets.
Ijara is a leasing agreement under which the bank (lessor) leases machines, equipment, installations, constructions or other facilities to the client (lessee) at an agreed upon rental fee. The lessee will get the full benefits of the leased asset, for a specified period, as long as he adheres to the Ijara terms and conditions. By the end of the Ijara period, assets are returned to bank possession, which in its turn will seek another user with the same need.
Ijara Muntahia Bitamalok Lease ending in ownership or Ijara Wa Iqtina Lease with acquisition are other variants of Ijara, which features the transfer of ownership of the leased asset from the bank to the client at the end of the Ijara period at a pre-negotiated price. This form of financing could be used for housing finance.
Ijara Mawsoofa Bil Zimma is a form of Forward Priced Lease or Future Lease. Usually this type of Ijara is preceded by an Istisnaa agreement. The lessee will pay pre-rentals provided that upon completion of the asset, it will be leased to him. The bank will have to repay all pre-rentals if asset was not manufactured or executed according to specifications laid down in the agreement.
A contract between the bank and the client whereby payment is made in advance for delivery of specified commodity in the future. The goods, quantity, quality, price, the date and place of delivery should be specified in the contract.
Contrary to Murabaha, here the payment is made by the bank in advance and the delivery of good is deferred. The price is usually expected to be higher than the initial price paid by the bank.
Salam transactions are mostly used in trade commodities including the agricultural field, with tenor between 3 to 12 months.
Wadiaa concept refers to the basic Islamic principle that funds deposited at the bank under current accounts are regarded as a Trust, and that the bank is the keeper and trustee of these funds.
The client will enjoy interest-free safekeeping services. In return, the bank is given the authority to use the client's funds, nevertheless, guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, anytime asked by depositor.
In some cases, and at the bank's discretion, may be rewarded with a hiba or gift as a token of appreciation.
Qard Al Hassan
An interest free small loan where the borrower only repays the principal amount borrowed. Qard Al Hassan is a small loan created on a goodwill basis mostly used to assist needy people.
Bayh Bithaman Ajil
A deferred sales contract primarily used for long-term financing. It is similar to Murabaha, except that the client makes only a single installment, on the maturity date. The price includes a profit margin agreed to by both parties.
A contract of guarantee made between the bank and a 2nd party whereby the bank guarantees the performance of the contract terms by contracting parties and pledges to discharge the liability of a 3rd party in the case of default. As a guarantee, the 3rd party will provide the bank with some form of collateral and pay a small fee for the service.
Similar to Power of Attorney or agency, by which a person delegates a representative, for specific purposes and under specific conditions, to undertake transactions on his/their behalf. As an agent, the bank will charge a specified fee for the services it provides.