Islamic Banking: Philosophy and Modes of Islamic Banking

Islamic banking refers to banking activities based on the principles and values of Islam and Islamic laws. It is governed by the risk management rules laid down by the Islamic Shariah, which prohibits any unethical transactions. The payment and acceptance of interest-based transaction is strictly prohibited in Islam.  Islamic banking also works by contributing to the attainment of objectives of the respective Islamic economy.

Islamic Banking: What is the Philosophy of Islamic Banking?

Although interest-based transactions are forbidden in Islamic banking, it does not forbid all profits on capital. As enshrined in the Verse 2:275 of the Holy Quran, financial activities under Islamic banking are enabled to cause value addition.

The Islamic banking system is based on:

• Risk Sharing
• Owning and Handling Material Goods
• Participation in the Trading Process
• Leasing and construction contracts using Islamic modes of finance 

As mentioned in the Verse II: 275, Allah did not deny the seeming similarity between Riba in loaning and trade profit in credit sale. However, while practicing trade is permitted, Riba is forbidden in Islam.

Islamic Banking: What are the Major Modes of Islamic Banking?

Here are some major modes of Islamic Banking and finance:

• Murabaha: It is a contract of sale, which includes declaration of cost and profit by the seller. The sale and profit is mutually agreed on by both the parties.
• Ijarah: It is the contract specifying the lease, rent or wages proposed to be given to someone in return for a proposed service taken or work expended by that person.
• Ijarah-Wal-Iqtina: It is referred to a contractual agreement wherein an Islamic bank offers equipment or assets to a person based on a unilateral undertaking by either the bank or the client that at the end of the lease period, the ownership of the asset shall be transferred to the lessee.
• Istisna’a: It is a legal agreement to produce goods and commodities, with a provision for advance payment and future delivery of goods, or future payment and future delivery of goods.