What is Islamic banking?
Islamic banking is banking based on Islamic law (Shariah). It follows the Shariah, called fiqh muamalat (Islamic rules on transactions). The rules and practices of fiqh muamalat came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad).
Islamic banking in Malaysia
• The first Islamic bank was established in Malaysia in 1983.
• In 1993, commercial banks, merchant banks and finance companies begun to offer Islamic banking
products and services under the Islamic Banking Scheme (IBS banks).
• The IBS banks have to separate the funds and activities of the Islamic banking transactions from the non-Islamic banking business (conventional banking).
Observing Shariah principles
All Islamic banks and IBS banks have set up Shariah Committees to guide them on Shariah matters and to make sure that they function in a manner that is in line with the Shariah. In addition, the advice of the Shariah Advisory Council which is the highest Shariah body set up at Bank Negara Malaysia, can be sought to ensure
uniformity in views and practices. The members of the Shariah Committees and the Shariah Advisory Council are academicians and Shariah experts in Islamic banking and finance.
Shariah concepts in Islamic banking
The common Shariah concepts are as follows:
Wadiah (Safekeeping)
Wadiah means custody or safekeeping. In a Wadiah arrangement, you will deposit cash or other assets in a bank for safekeeping. The bank guarantees the safety of the items kept by it.
Here is how it works:
1) You place money in a bank and the bank guarantees to return
the money to you.
2) You are allowed to withdraw the money anytime.
3) Bank may charge you a fee for looking after your money and may pay hibah (gift) to you if it deems fit.
4) This concept is normally used in deposit-taking activities,custodial services and safe deposit boxes.
Mudharabah (Profit sharing)
Mudharabah is a profit sharing arrangement between two parties, that is, an investor and the entrepreneur. The investor will supply the entrepreneur with funds for his business venture and gets a return on the funds he puts into the business
based on a profit sharing ratio that has been agreed earlier.
The principle of Mudharabah can be applied to Islamic banking operations in 2 ways: between a bank (as the entrepreneur)and the capital provider, and between a bank (as capital provider) and the entrepreneur. Losses suffered shall be borne by the capital provider.
Here is how it works:
1) You supply funds to the bank after agreeing on the terms of
the Mudharabah arrangement.
2) Bank invests funds in assets or in projects.
3) Business may make profit or incur loss.
4) Profit is shared between you and your bank based on a preagreed ratio.
5) Any loss will be borne by you. This will reduce the value of the assets/ investments and hence, the amount of funds you have supplied to the bank.
Bai’ Bithaman Ajil – BBA (Deferred payment sale)
This refers to the sale of goods where the buyer pays the seller after the sale together with an agreed profit margin, either in one lump sum or by instalment.
Here is how it works:
1) You pick an asset you would like to buy.
2) You then ask the bank for BBA and promise to buy the asset from the bank through a resale at a mark-up price.
3) Bank buys the asset from the owner on cash basis.
4) Ownership of the goods passes to the bank.
5) Bank sells the goods, passes ownership to you at the mark-up price.
6) You pay the bank the mark-up price in instalments over a period of time.
Murabahah (Cost plus)
As in BBA, a Murabahah transaction involves the sale of goods at a price which
includes a profit margin agreed by both parties. However, in Murabahah, the seller
must let the buyer know the actual cost for the asset and the profit margin at the
time of the sale agreement.
Musyarakah (Joint venture)
In the context of business and trade, Musyarakah refers to a partnership or a joint
business venture to make profit. Profits made will be shared by the partners based on an agreed ratio which may not be in the same proportion as the amount of investment made by the partners. However, losses incurred will be shared based on the ratio of funds invested by each partner.
Ijarah Thumma Bai’ (Hire purchase)
Ijarah Thumma Bai’ is normally used in financing consumer goods especially motor
vehicles. There are two separate contracts involved: Ijarah contract (leasing/renting) and Bai’ contract (purchase).
Here is how it works:
1) You pick a car you would like to have.
2) You ask the bank for Ijarah of the car, pay the deposit for the car and promise to lease the car from the bank after the bank has bought the car.
3) Bank pays the seller for the car.
4) Seller passes ownership of the car to the bank.
5) Bank leases the car to you.
6) You pay Ijarah rentals over a period.
7) At end of the leasing period, the bank sells the car to you at the agreed sale price.
Wakalah (Agency)
This is a contract whereby a person (principal) asks another party to act on his behalf(as his agent) for a specific task. The person who takes on the task is an agent who will be paid a fee for his services.
Example
A customer asks a bank to pay someone under certain terms. The bank is therefore the agent for carrying out the financial transaction and the bank will be paid a fee for its services.
Qard (Interest-free loan)
Under this arrangement, a loan is given for a fixed period on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrower
may, if he so wishes, pay an extra amount (without promising it) as a way to thank the lender.
Example
A lender who lent RM5,000 to a borrower on Qard will expect the borrower to return exactly RM5,000 to him at a later date.
Hibah (Gift)
This refers to a payment made willingly in return for a benefit received.
Example
In savings operated under Wadiah, banks will normally pay their Wadiah depositors hibah although the accountholders only intend to put their savings in the banks for safekeeping.
(This info is just for your understanding. Always get further explanation from your bank on any doubts)
