Islamic banks are distinct financial institutions that are guided by ethical and Shari’ah-compliant principles. These principles set them apart from the traditional banks by ensuring that their operations and processes are compliant with Islamic law and guidelines. The following are some essential guidelines that Islamic banks ought to follow.
Shari’ah Compliance: Shari’ah, the Islamic legal system, is the cornerstone of Islamic banking and regulatory framework. All financial activities and transactions must adhere to the principles outlined in the Quran and Hadith (the sayings and actions of Prophet Muhammad) which are considered the primary sources of Islamic law. Islamic banks should avoid interest (usury), unethical investments, and speculative practices, and instead, engage in risk-sharing arrangements, wherein clients share both gains and losses.
Profit and Loss Sharing: Islamic banks are expected to follow modes of finance such as Mudarabah (venture capital) and Musharakah (partnership) that provide sharing of profits and losses with their clients. In Mudarabah, one party provides the capital, and the other manages the business. Profits are shared based on an agreed-upon ratio, but losses are strictly borne by the capital provider. In Musharakah, both parties contribute their capital and expertise in the business, while profits and losses are shared according to their capital contribution. This encourages risk-sharing, fairness and transparency.
Mitigation of Risk and Ethical Investments: Islamic banks aim to minimise excessive risk-taking. They avoid speculative transactions and focus on investments in real assets and economic activities with tangible value. This helps protect both the bank and its clients from undue financial risks. This is considered one of the main reasons why Islamic financial institutions were not affected by recent financial crisis. Islamic banks avoid financing businesses involved in transactions and activities prohibited by Shari’ah, such as alcohol, gambling, and pork. Instead, they support projects and ventures that contribute positively to society and the economy.
Transparency, Fairness and Justice: Islamic banks are required to disclose all relevant information to clients, ensuring they make informed decisions. This transparency extends to profit and loss distribution, as clients should be aware of how their funds are being utilised. Loans and financial agreements should be structured to prevent exploitation and ensure equitable terms for all parties involved.
Prohibition of Riba (Usury), Uncertainty (Gharar) and Fraud (Maysir): Islamic banks do not charge or pay interest. Instead, they engage in profit and loss-sharing arrangements that align with the belief that money should not increase over time without productive economic activity. Islamic contracts should be clear and not involve excessive ambiguity, speculation, or hidden information, ensuring honest agreements.
Islamic banks play a vital role in the global financial system, guided by principles deeply rooted in Islamic law. These principles prioritise fairness, ethical conduct, transparency, and the concept of risk-sharing. By adhering to these principles, Islamic banks create a financial environment that is fair, more equitable and socially responsible. They also ensure that Islamic banks serve as a source of financial support and stability for both individuals and businesses while upholding the values and ethics of Islamic law. In a world where ethical banking practices are increasingly valued, Islamic finance principles are not only important for the Islamic banking sector but can also serve as a source of inspiration for the broader financial industry.
Shari’ah, the Islamic legal system, is the cornerstone of Islamic banking and regulatory framework. All financial activities and transactions must adhere to the principles outlined in the Quran and Hadith (the sayings and actions of Prophet Muhammad) which are considered the primary sources of Islamic law. Islamic banks should avoid interest (usury), unethical investments, and speculative practices, and instead, engage in risk-sharing arrangements, wherein clients share both gains and losses.
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