WESTERN (CONVENTIONAL) AND ISLAMIC BANKING

A Leveled Comparative Analysis between Western (Conventional) and Islamic Banking

A Leveled Comparative Analysis between Western (Conventional) and Islamic Banking

Chapter IV

Introduction

What is Islamic banking and finance? The Qur'anic foundations of IBF

It is important to understand some of the main features of IBF and how they translate into financial practices. But this is no easy task. IBF, as we shall see, is an elusive, contested, evolving and heterogeneous set of practices that defies simple description or conceptualization. The most basic starting point, however, is to note that IBF is rooted in the rules and norms of Islam, and in particular Shari'a law, which emerges out of the Qur'an , and the prophet Mohammed through the Sunnah . The Sunnah (or an explanation of the Qur'an condensed into ways of acting) is derived from the Hadith - that is the tradition or story of the Prophet. From Shari'a law there are two broad concerns that structure the practices of IBF and provide some points of contrast with Western finance.

First is the prohibition of riba (increase) as it is viewed as exploitative and unfair. 4 The prohibition of riba does not mean that money may not be lent under Islamic law, but merely rules out what might be considered unearned profit. 5 The provider of capital is not permitted to fix a predetermined rate of interest, but should be allowed an adequate return by having a financial stake in the project to be undertaken. That is, money is not considered a commodity in Islamic economics, but rather a bearer of risk. A second suite of concerns affecting IBF is the prohibition of excessive risk or uncertainty ( gharar ); Islamic institutions shun investments into gambling, but also certain kinds of businesses, especially those involved with porkrelated products, alcohol, prostitution and other forms of entertainment deemed unacceptable. More generally, Islamic law frowns on speculation and stresses the 'asset-based' qualities of IBF practices.

A key aspiration in IBF - in sharp contrast to interest-based finance - is a close coupling of the financial and the 'real' economy. Financiers are encouraged to invest in promising projects, to share profits and losses with entrepreneurs and, in so doing, promote development. Money is to be tied to real (material) assets to make them grow; it cannot be used as a commodity in and of itself or used as collateral. If it is not clear whether a particular financial practice is acceptable based on a ruling from the Ijtihad (which literally means 'effort', but is essentially the interpretation of Qur'anic texts).

The concept of ijtihad is vital to the contemporary practice of IBF, especially as it develops in non-Islamic banking and financial systems. Islamic scholars meet communally to arrive at decisions and issue a fatwa (opinion) and these become part of Islamic jurisprudence. 6 In practice, this means that Islamic banks or financial institutions are regulated by Shari'a boards, comprising one or more Islamic scholars, which offer a fatwa or statement of ...