Wednesday, November 21, 2012

Islamic Banking

Islamic banking Principles, relevance of Islamic banking for UAE and how Islamic banking different from traditional banks.

The principles of Islamic law derive from interpretations of two sources: the Qur’an and the Sunna. The central pillars of Islamic finance are that wealth must be generated from legitimate trade and asset-based investment, while the use of money for the purposes of making money is expressly forbidden. Crucially, the latter means that Islamic finance does not permit the charging or paying of interest (riba). Under Islamic principles, investment must also have a social and an ethical benefit to wider society, with short-term speculative investments (known as masir) strictly forbidden. Islamic finance also prohibits investment in sectors classified as inappropriate on moral grounds by shariah law. These include industries involving alcohol, gambling, or drugs, but can extend well beyond these narrow boundaries. Each Islamic bank’s adherence to the principles of shariah law is governed by its own shariah board, a body charged with the responsibility of overseeing all processes of the bank. While some aspects of shariah law may be subject to individual interpretation, the board also has the responsibility to decide which proposed deals are acceptable to the bank on shariah grounds, and which are not.

Given that Islamic finance forbids the charging of interest, banks must earn their profits through the provision of fee-based services, or through a kind of partnership with clients in which both the risk and the profits or losses are shared between the bank and the customer, according to pre-agreed conditions. Such arrangements typically allow the client to draw a salary from the business, which is then deducted from profits. Shariah law also permits a range of leasing-style agreements under which the bank can buy an asset on behalf of a customer, then charge a regular, pre-agreed rental fee. As in mainstream Western banking, these agreements can be fixed-term operating leases or lease purchases, with the latter obliging the client to buy the asset at the end of the period, at a predetermined price. While some leasing arrangements can be relatively straightforward, others can become more complex, depending on how the asset is originally purchased by the bank. Given that Islamic finance does not permit the charging of interest, a bank originally buying the asset on the basis of a variable interest rate may seek an arrangement by which the rental charge is increased, to effectively compensate any increase it faces in financing costs. 

In the UAE, Islamic Finance is applied in its own market, as the case may be in other parts of the world. Conventional and Islamic forms of financial services simultaneously exist in the same country; in fact, almost all conventional banks offer “Islamic Windows” which offer “Halal” solutions. As the UAE aims to be a global player in the world of finance; it has to deal with other banks in the major financial centers. As such, conventional banking is an element which cannot be replaced at this stage of time. The demand on Islamic Banks has been high in the UAE due to the large Muslim community which lives in the country.

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