LECTURE 2: AN BRIEF
INTRODUCTION TO MONEY AND
ISLAMIC BANKING
SHARIAH BASIS
Shariah is the origin and basis of Islamic banking, for
example, Islamic Laws and sometimes the Islamic
jurisprudence referred.
The teaching of Islam includes:
 The essence of economic well-being;
 Development of Muslim at the individual, family, society,
state and “Ummah” (Islamic universal community) levels.
BRANCHES OF ISLAM
Islam compromises of three basic elements:
Aqidah concerns all forms of faith and belief by a
Muslim in Allah and His will, from the fundamental faith
in His being to the ordinary beliefs in His individual
commands (Ahkam).
Islamic law covers all forms of practical actions by a
Muslim manifesting his faith and belief.
Akhlaq concerns behavior, attitude and work ethics with
a Muslim performs his practical actions.
Islamic law as the practical aspects of a Muslim’s
daily life is then dived into:
Ibadat & Muamalat
Ibadat is concerned with the practicalities of his
worship to Allah, in the form of man-to-Allah
relationship.
But Muamalat is concerned with the practicalities of
his mundane daily life, in the form of man-to-man
relationship.
One of the significant segments of Muamalat is the
conduct of a Muslim’s economic activities within his
economic system.

- The banking and financial system
COMPLIANCE WITH THE SCHEME OF SHARIAH LAWS
Within the Islamic way of the life and Shariah
framework, Islam imposes its “ahkam” (laws) – or in
modern terminology sometimes referred to as norms
or values – on its believers.
These laws or values are not man-made; rather they
are ordained by Allah. They are derived from the
sources of Shariah such as Al-Quran and AlSunnah.
Banking and financial activities being part and parcel
of Muamalat, are therefore subject to the Shariah
Laws on Muamalat.
EQUITY AND DEBT IN ISLAM
According to Islam:
Equity, a very notable feature of Shariah is the fact
that al-Quran does not directly deal with it at all. It
was left to al-Sunnah to clarify the issue. And alSunnah confirms that the profit sharing contracts
such as Mudarabah, Musharakah and other similar
contracts that had been practiced by the pre-Islamic
Arab are all allowed in Islam.
Al-Quran is silent on the equity while it comes out
strongly on debt. Al-Sunnah also handles
extensively with debt.
The verdict is:
Deferred contracts of exchange are allowed in Islam;
whereas interest-based lending is forbidden.
Equity financing is to be conducted through profitsharing contracts while the debt-financing by
deferred contracts of exchange.
Lending is still allowed in Islam, but it has to be
without interest. In Shariah, this kind of lending is
called “al-Qard Al-Hasan” (Benevolent loan).
Major differences in equity-financing and debt financing
in Islamic Finance and conventional finance:
In equity financing, there are no major difference
between Islamic and conventional finance.
However major differences between these two systems
appear on debt financing.
Debt financing in conventional system is almost totally
based on interest based lending, while this contract is
forbidden in the Islamic financial system.
THE COMPONENTS OF THE ISLAMIC
BANKING SYSTEM
The Islamic banking system has five components:
1.
Money
2.
Financial instruments
3.
Financial markets
4.
Financial institutions
5.
Central bank
MONEY
What is money ?
Back by gold ?
Fiat Money ?
Fractional Reserve system?
FINANCIAL INSTRUMENTS
Products of contracting parties such as deposit products and financing
products;
They are derived from the basic sources of Al-Quran and Al-Sunnah;
Secondary soucres: Ijma, Qiyas, Maslahah, Istihsan, Urf, etc.
The shariah principles that are derived from these sources have to
translated into the language of banks;
FINANCIAL MARKETS
Originally, the financial transactions occurred in a located market such
as an office of Islamic bank;
Sukuk
Shariah-compliant stocks
Others – Mutual fund, Wealth Management
FINANCIAL INSTITUTIONS
Islamic banks started as institutions that accepted money and made
financing;
Now, they developed into institutions like financial supermarkets;
A lot of financial products;
Services for sale;
Saving products;
Financing products like home financing , even
takaful;
Investment advices;
CENTRAL BANK
Nearly every country in the world has one central bank;
One of the most important institutions in government;
Roles of central bank:
It issues currency and keeps the reserves;
It acts as a banker and financial adviser to the
government;
It promotes monetary stability and a sound financial
structure;
It influences the financing situations to aid the
economy;
THE PRINCIPLES OF MONEY AND ISLAMIC
BANKING
Principle 1: Money as Medium of exchange
Conventional system: time has value- interest;
In Islam, the paying or receiving of interests is prohibited; the owner
of capital is compensated based on profits;
The difference between profit and interest:
1)
Profit is not pre-determined rate of return;
2)
Has a probability of loss as well;
PRINCIPLE 2: RABBUL MAL AND MUDARIB
RELATIONSHIP
Rabbul mal provides the capital and mudarib undertakes the
management;
The Mudarib acts as:
1) Trustee to look after the investment responsibility;
2) As an agent (wakeel) purchase from the funds which
provided by rabbul mal;
3) As a partner (Shareek) for sharing in any profit;
PRINCIPLE 3: RISK SHARING
No reward without risk sharing/bearing;
Both rabbul mal and mudarib should share the risk of business
ventures based on capital contributions or pre-determined ratio;
In conventional baking: the pressure is on the borrower;
PRINCIPLE 4: MARKETS SET PRICES AND
GENERATE PROFITS
As narrated by Anas: during the life time of the Prophet (SAW) the
price levels went up. People said “Prophet (SAW), fix the prices for
us.” on this, the Prophet (SAW) said “prices are fixed by Allah; He
contracts and expands the sources of livelihood and I hope to meet my
Sustainer (Allah) in a state that no one may raise a claim of injustice
against me in respect of blood and money.”
Therefore, markets are the core of the Islamic economic system.
PRINCIPLE 5: ISLAMIC BANKING
STABILITY
Economic stability means to protect the economy from the vicissitudes
of financial system;
Prudent management of risks is essential for ensuring the stability of
Islamic banks;
Risks can be managed by adopting a standard regulatory and
supervisory framework and by having a sound internal Islamic
banking policy;
PRINCIPLE 6: ISLAMIC BANKS AS AGENTS
FOR ECONOMIC GROWTH
Money is channeled through Islamic banks, then utilized for the
economy;
Islamic banks are able to: evaluate projects, manage risks, monitor
risks and facilitate transactions;
TWO APPROACHES TO ISLAMIC
ECONOMICS AND FINANCE
The modern Islamic finance is not built directly from the Shari’ah
(Shari’ah based approach) but rather from the Islamically modified
conventional banking (Shari’ah compliant approach);
The results are high costs, low profits and most importantly, a dilution
of respectability.
It must progress from being Shari`ah compliant to being Shari`ah
based.
TWO APPROACHES TO ISLAMIC
ECONOMICS AND FINANCE
While the Shari’ah-compliant briefly means borrowed from the west
after being made compliant to the Shari’ah, the Shari’ah-based simply
means not borrowed from the west but evolved from the original
sources of Islam.
FOUR BASIC WEAKNESSES OF THIS
SHARI’AH COMPLIANT APPROACH:
First, because its initial starting point is a western institution or
instrument, it is basically imitative. Consequently, it does not contribute
anything new to the humanity`s treasure box of accumulated wisdom
and does not command respect. After all, it is a universal rule that
imitators do not deserve respect but original contributors do.
Second, although it is claimed that this approach allows Muslims to
perform in an economic environment dominated by western modes, it
has been shown that it does so at the expense of increased costs and
reduced profits.
Third, all of these bear with them substantial Shari`ah risks, in the
sense that, the public may become disenchanted by these instruments
so similar and even benchmarked to the interest rates prevalent in the
west.
Fourth, highest profits are usually obtained when a new financial
instrument is introduced for the first time.
Since reverse engineering focuses on western instruments introduced
long ago, it tries to convert models whose profits have already
diminished.
CONCLUSIONS:
Islamic finance has to develop its own genuinely Islamic financial
instruments.
So far, Muslims have been free riding on financial theories and
instruments developed by the West. Unless Islamic finance develops its
own genuinely Islamic financial instruments, it cannot achieve the
dynamism of a system that provides the security, liquidity and diversity
needed for a globally accepted financial system, which would be a
genuine alternative to the present debt-interest based international
system.