The Basis of Islamic Banking

(Riba’, Gharar, Maysir, Khatar & Ethics)

and Comparison With Conventional Banking

SystemPresented by:

Hanis Syahirah binti Zulkefli (1120453)Nur Syakirah binti Maimun Aqsha (1120456)Salmah binti Rabun (1122019)Rafidah binti Arifin (1122022)Nabilah binti Mat Som (1122024)

Riba is an Arabic word, derived from the verb raba that literally means ‘to grow’ or ‘expand’ or ‘increase’ or ‘inflate’ or ‘excess’

In fiqh terminology, riba means an increase in one of two homogeneous equivalents being exchanged without this increase being accompanied by a return.

Riba’

The Prohibition Of Riba’ In Quran “Those who devour riba will not stand except as one whom Satan has driven to madness by his touch will stand. That is because they say: ‘Trading is like riba’, and Allah has allowed trading and forbidden riba. So to whoever takes the admonition from his Lord, then he desists, he shall be pardoned for the past, and his affair is committed to Allah, but whoever reverts, those are the inhabitants of the Fire, to dwell therein forever…..” [2:275-281]

The Prohibition Of Riba’ In Sunnah Another hadith is one narrated by Abu

Sa`id al-Khudri from the Prophet who said:

“Do not sell gold for gold, except when it is like for like, and do not increase one over the other; and do not sell silver for silver except when it is like for like, and do not increase one over the other; and do not sell what is away (from among these) for what is ready”

RIBA AL- NASI’AH

The term nasi’ah means to postpone or to wait and it refers to the time period that is allowed for the borrower to repay the loan in return for the addition of the premium. Hence it refers to the interest on loans. The prohibition of riba al nasi’ah essentially implies that the fixing in advance of a positive return on a loan as a reward for waiting is not permitted by the Shari’ah .

RIBA AL-FADL

Riba al-fadl is the excess over and above the loan paid in kind. It lies in the payment of an addition by the debtor to the creditor in exchange of commodities of the same kind. The following tradition of the Prophet Muhammad (saw) is cited as evidence.

It is related that Abu Said al-Khurdi said: “the Prophet Muhammad (saw) has said that gold in return for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt, can be traded if and only if they are in the same quantity and that is should be hand to hand. If someone gives more or takes, then he is engaged in riba and accordingly has committed a sin.”

To sum up, riba al-nasi’ah and riba al-fadl are both covered by the verse, “Allah has allowed trade and prohibited riba” (2:275), while riba-al nasi’ah relates to loans and riba al-fadl relates to trade

Although trade is allowed in principle it does not mean that everything in trade is allowed

The Distinguishing Features of The

Conventional Banking & Islamic Banking

(in term of Riba’)

CONVENTIONAL BANKING ISLAMIC BANKING The functions and operating modes of conventional banks are based on man-made principles.

The functions and operating modes of Islamic banks are based pn the principles of Islamic Sharia’h.

The investor is assured of predetermined rate of interest.

In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepeneur)

It aims at maximising profit without any restriction

It also aims at maximising profit but subject to Shari’ah restrictions.

Lending money and getting it back with interest is the fundamental function of the conventional banks.

Participation in partnership business is the fundamental function of the Islamic banks.

It can charge additional money (compund rate of interest) in case of defaulters.

The Islamic banks have no provision to charge any extra money from the defaulters

For interest based commercial banks, borrowing from the money market is relatively easier.

For islamic banks, it is comparatively difficult to borrow money from the money market.

The status of conventional bank has to guarantee all its deposits.

The status of Islamic Banks in relation to its clients is that of partners, investors and trader.

Since Islamic banks do not rent money, and therefore do not charge interest, they have developed some investment techniques such as bai` murabahah, musharakah and mudarabah in order to invest money and make profit

In any of these techniques, profitability and installment of repayment are identified beforehand

Gharar

Ibn Taymiyyah from the Hanbali school defines gharar as “that whose outcomes are unknown”

“Gharar is trading in risk” (El-Gamal, 2000)

“Gharar is a broad concept in that it comprises uncertainty and risk-taking as well as excessive speculation, gambling and ignorance of the material aspects of contract” (Kamali, 2000:96)

Various clarification of gharar (uncertainty) include pure speculation where the outcome depends on chance or gambling, uncertain outcome where the counter-value is uncertain or not realized, inexactitude of object, and unknown future of object.

For example, the Prophet (pbuh) has forbidden the purchase of the unborn animal in the mother’s womb, the sale of the milk in the udder without measurement, the purchase of spoils of war prior to distribution, the purchase of charities prior to their receipt, and the purchase of the catch of a diver

The Rationale Behind the Prohibition To ensure full consent and satisfaction of

the parties in a contract Full consent can only be achieved in full

disclosure and transparency and through perfect knowledge from contracting parties of the counter values intended to be exchanged

Protects against unexpected losses and the possible disagreements regarding qualities or incompleteness of information

Contract of Investment vs. Contract of Exchange Whether a gain is made by one of the

partners at the expense of the other? So long as each partner's contribution

commands a freely negotiated percentage share of the final profit or loss, then neither can be said to have devoured the wealth of the other unjustly

There is certainly a lack of knowledge, but not of the type that benefits one party at the expense of another

Whatever profit or loss arises will be shared fairly between the partners – contract of investment e.g. musharakah investment

Each counter-value must be precisely known at the time of contracting – contract of exchange

Insurance vs. Takaful

An insurance contract contains gharar because when a claim is not made one party (insurance company) may acquire all the profits (premium) gained whereas the other party (participant) may not obtain any profit whatsoever

The concept of insurance where resources are pooled to help the needy does not necessarily contradict Islamic principles

Takaful Islamic Insurance Conventional Insurance Based on mutual assistance agreement and a combination of donation (Tabarru), agency (Wakala) and or profit sharing (Mudaraba) contract between the operator and participants

 Based on sale and purchase contract between the insurer and the insured

 A contract based on mutual contribution by the participants

Sale or purchase contract between policyholders and insurers

 Takaful operators make use of participants contribution only for the intended purpose of “joint guarantee”

 The operator use the premium paid by policyholders in investments in order to suit his shareholders needs

Takaful participants have a share in the surplus and profits of the risk and investment funds respectively based on a pre agreed ratio between the operator and the participants

Policyholders have no share in the business of the company

Takaful Islamic Insurance Conventional InsuranceTakaful participants contribute to the scheme as part of fulfilling or adhering to the injunctions drawn from the Qur’an that says “Help one another in goodness and piety but help not in sin and transgression” (Holy Quran 5:2)

The insurer is driven by the desire to make profit for his company without any moral restrictions

Takaful operator is strictly guided to invest his funds in accordance with the provisions of Shariah and that of prudential requirements

 The conventional insurance operator is guided by prudential requirements only

Maysir

Also known as qimarDefinition : making an easy gain in

a competitive game at the expense of other participant/s without any effort

Win/lose by mere chance The gain is an unwarranted reward

and so is the loss Maysir (yasara) – the gambler seeks

to amass wealth easily without effort

The Prohibition Of Maysir In Quran

In Holy Quran,

Surah al-Ma’idah,verse 90 – sows the seeds of enmity and rancour among people.

Surah al-Baqarah, verse 219 – in both is greaty sin, and utility for men, but the sin in them is greater than their usefulness.

Gambling is also subsumed under the broader Quranic prohibition of wrongful devouring of the property of others

The risk in gambling is a staged event which is created by the parties and would not exist otherwise

Examples: horse racing, lottery

All agreements and contracts which involve elements of chance that violate the principle of equivalence in commercial transactions and seek unwarranted gain partake in maysir and therefore prohibited

Shariah scholars usually brought up the gambling issue as one of the underlying prohibitions of Islamic finance

Financial transactions implicated are: Insurance Commodity forward trading Financial futures and options

There has been arguments and legal opinions (fatwas) that all these transactions are gambling

Khatar(Risk)

Definition A type of gharar (uncertainty) that arises if

liability of any of the parties to a commutative contract (‘aqd muawadhah) is, or becomes, uncertain or contingent on unforeseen/uncontrollable events. Khatar may also arise if delivery of one of the counter values (in an exchange-based contract/commutative contract) is uncontrollable by any party, or if the object of sale or the amount of payment (thaman/badal) is undetermined.

Khatar خطر) ) is an Arabic term for harmful or dangerous risk.

Ibn Taymiyyah (728H-1328G) defined risk (khatar) asfollows: “Risk falls into two categories: commercial risk,where one would buy a commodity in order to sell it forprofit, and rely on Allah for that. This risk is necessary

forMerchants, and although one might lose sometimesthis is the nature of trade. The other type of risk is that of gambling, which implies eating people’s wealth fornothing. This is the type that Allah and His Messengerpbuh) have prohibited.”

Types of risk

Commercial

Gambling

Risks in islamic banking

Financial Credit Market Business Treasury Governance

Risks in conventional banking Market risk Credit risk Liquidity risk Operational risk Other types of banking risks

Conclusion

Risk in any transaction may exist due to many reasons

It can be due to natural causes (e.g. good weather conditions or not), time allocation outcome, and market outcome

The existence of all these risks is inevitable to everyday transaction

As such, the existence of risk alone does not render a contract invalid

Risk is something that is beyond our control.

Ethics in Conventional Bank &Islamic Bank

Introduction

What is Ethical Banking?

Ethical banking is the term that encompasses any banking system that embraces environmentally and socially conscious practices. While the banks still try to earn profits, they try to do it in the way that's consistent with their practices.

The key to ethical banking is deciding on the common set of principles and sticking to them no matter what.

Differences

Risk vs. CapitalISLAMIC BANK CONVENTIONAL BANK

Islamic bank will mediate the relationship between its aggregate depositors and its aggregate borrowers

Conventional bank will take ownership of the depositors' funds and become theborrower's partner

If the Islamic bank is profitable, the depositors are entitled to a share of those profits

conventional banking format, the ownersof a bank are more at risk than the depositors

Islamic banks located in the developing world do not offer such guarantees. Even if such systems were available, it is doubtful that they could offer similar levels of security

the support provided by central banks to depositors in case of bank failure.

work well in systems where the entire economy is based on Islamic principles and all the banks are Islamic (Pakistan & Iran)

dissuades poor judgment by forcing owners to bear the financial burden of those poor decisions while generally shielding depositors from the same level of loss

PricingISLAMIC BANK CONVENTIONAL BANK

computes its pricing as profit sharing ona given instrument or transaction

price its services according to what the market can bear

This minimum is computedas follows:• It must cover the cost of

running the bank. • It must permit the build up of a

reserve for bad loans. • The bank must then estimate

its profit and thus the return to its shareholders.

• The cost of regulatory processes, if any, must be included.

• It must estimate the amount of profits it will have to pay to its depositors to keep them as depositors.

Pricing must: • cover the expense of running the

bank, including staff salaries, rent, depreciation of equipment, communication expenses, etc.;

• allow the bank to build a reserve for bad loans;

• provide shareholders with a minimum return on their investments that matches alternative investment potential;

• account for regulatory and FDIC insurance processes; and

• cover the cost of funds of the bank: interest payments to private and corporate depositors and payment for borrowings from other banks, including the central bank.