The Origins and Fundamentals of Islamic Banking

Abstract

Islamic banking is one of the fastest growing industries in global finance. New institutions are adapting Islamic financial products and services with increasing attention from academics and practitioners all over the world. Similar to conventional banks and other financial institutions, Islamic banks are private profit-seeking enterprises. Nevertheless, the latter is guided by the principles of Islamic law (Shariah) which strictly prohibits dealing with the interest (Riba), uncertainty (Al-Gharar), gambling (Al-Maysir) and some other financial products and services. This chapter first provides a detailed assessment of the religious sources underpinning Islamic banking, comprising the primary sources of the Holy Qur'an and the Sunnah of the Prophet PBUH (collectively known as Al-wahyain or the Two Revelations), and secondary sources subsequently derived from the work of Muslim scholars, namely, the Al-Ijma' (or scholarly consensus) and Al-Qiyas (or analogy). The chapter then outlines the key financial products and services commonly practiced by Islamic banks, include Murabahah (cost-plus sales); Musharakah (full partnership); Mudarabah (silent partnership); Ijarah (Leasing); Istisna' (contract of manufacture); and Al-Qard Al-Hassan (benevolent loan). The final part of the chapter discusses the evolving definition of Islamic banking, the fundamental differences between conventional and Islamic banks, and the process of transformation to Islamic banking as experienced by new and existing banks.