(Sharia'a) principles and guided by Islamic economics. In particular, Islamic law forbids usury (also called riba ), the collection and payment of interest.

Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of gambling).

In addition, Islamic law forbids investing in business that is considered haram (such as business that sells alcohol or ham)

In the late 20th century, a number of Islamic banks were created, to supply this particular banking market.

History of modern Islamic banking

The first modern experimentation with Islamic banking was in Egypt under cover, without projecting an Islamic image, for fear of being seen as a sign of Islamic fundamentalism which was abhorrence to the political regime.

The revolutionary effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967

Principles in Islamic Banking

Islamic banking has the same idea as conventional banking except that it claims to operate in harmony

with the rules of Sharia'a , known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of

Islamic banking is the sharing of profit and loss and the ban of riba´ (interest). Amongst the common

Islamic concepts used in Islamic banking are profit sharing ( Mudharabah ), safekeeping ( Wadiah ), and joint venture ( Musharakah ), cost plus ( Murabahah ) and leasing ( Ijarah ).

In an Islamic mortgage transaction, instead of loaning the buyer money to buy the item, a bank might purchase the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in payments. However, the fact that it is profit cannot be made clear and so there are no additional fees for late payment. In order to protect itself against failure to pay, the bank asks for strict collateral. The goods or Land is registered to the name of the buyer from the start of the transaction.

This arrangement is called Murabaha . Another approach is (Ijara wa Iqtina), which is similar to real estate leasing.

Islamic banks deal with loans for motor vehicle in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

There are several other steps used in business deals. Islamic banks lend their money to companies by issuing balanced rate interest loans. The balanced rate of interest is doweled to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits.

Once the principal amount of the loan is repaid, the profit-sharing arrangement is completed.

This practice is called ( Musharaka) .

Further, ( Mudaraba) is venture capital funding of an capitalist who provides work while financing is provided by the bank, so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not stand all the risk or cost of a failure, as it is Allah who determines that failure, and means that it fall on all those involved.

Last, Islamic banking is restricted to islamically acceptable deals, which prohibit those involving alcohol, ham, gambling, etc. Thus moral investing is the only acceptable form of investment, and moral purchasing is encouraged.

Islamic banks have grown recently in the Muslim world but are a very small share of the global banking system.

Micro-lending organizations such as Grameen Bank use conventional lending forms, and are popular in some Muslim nations, but are clearly not Islamic banking theoretically, Islamic banking should be identical with full-reserve banking, with banks achieving a 100% reserve relation.

However in practice this is rarely the

Case.

Sharia'a Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to set up Sharia'a advisory committees consultants to advise them and to ensure that the operations and activities of the bank comply with Sharia'a principles.

In Malaysia, the (National Syariah Advisory Council)additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Sharia'a aspects of the operations of these organizations, as well as on their products and services.

Concepts In Islamic debt banking

Wadiah (Safekeeping)

In Wadiah , a bank is deemed as a keeper and trustee of finances.

A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the exceptional amount, when the depositor demands it. The depositor, at the bank's carefulness, may be rewarded with a (hibah) or gift as a form of appreciation for the use of funds by the bank.

In this case, the bank compensates depositors for the time value of their money (i.e. pays interest) but refers to it as a "gift" because it does not officially guarantee payment of the gift.

Mudarabah (Profit Loss Sharing)

Mudarabah is an agreement between a capital provider and an capitalist, whereby the capitalist can mobilize funds for its business activity.

Any profits made will be shared between the capital provider and the capitalist according to an agreed relation, where both parties share in profits and only capital provider bears all the losses if occurred.

The profit-sharing continues until the loan is repaid.

The bank is compensated for the time value of its money in the form of a floating interest rate that is pegged to the debtor's profits.

Musharakah (Joint Venture)

This concept is normally useful for business partnerships or joint ventures. The profits made are shared on an agreed proportion, while losses incurred will be divided based on the equity participation proportion. This concept is distinct from fixed-income investing (i.e. issuance of loans).

Murabahah (Cost Plus)

This concept refers to the sale of goods at a price, which includes a profit frame agreed to by both parties.

The purchase and selling price, other costs and the profit limit must be clearly stated at the time of the sale agreement.

The bank is salaried for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset, with a fixed rate of interest determined by the profit margin.

The bank is not compensated for the time value of money outside of the contracted term, however the asset remains in the ownership of the bank until the loan is paid in full.

This type of transaction is similar to "rent-to-own" arrangements for furniture or appliances that are very common in North American stores.

Bai' Bithaman Ajil (Deferred Payment Sale)

This concept refers to the sale of goods on a late payment basis at a price, which includes a profit limit agreed to by both parties.

This is similar to Murabahah, except that the debtor makes only a single payment, on the maturity date of the loan. By the request of a discount rate, an Islamic bank can collect the market rate of interest.

Wakalah (Agency)

This happens when a person appoints a delegate to undertake transactions on his/their behalf, similar to a power of attorney.

ALqardul AL Hassan (Benevolent Loan)

This is a loan comprehensive on a goodwill basis, and the debtor is only required to repay the amount borrowed.

However, the debtor may, at his or her carefulness, pay an extra amount beyond the principal amount of the

loan (without promising it) as a token of appreciation to the creditor.

In the case that the debtor does not pay an extra amount to the creditor, this deal is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not infringe the prohibition on riba, since it is the one type of loan that truly does not compensate the creditor for the time value of money.

Ijarah Thumma Al Bai' (Hire Purchase)

These are differences on a subject of purchase and lease back transactions. There are two contracts involved in

this concept. The first contract, Ijarah contract (leasing/renting) and the second contract, Bai' contract

(Purchase) are undertaken one after the other.

For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed rental over a specific period.

When the lease period expires, the second contract becomes effective, which enables the customer to purchase the car at an agreed price.

In effect, the bank sells the product to the debtor, at an above market-price profit margin, in return for

agreeing to receive the payment over a period of time; the profit margin on the lease is equivalent to interest

Earned at a fixed rate of return.

This type of transaction is particularly reminiscent of (contractum trinius), a complicated legal trick used by

European bankers and merchants during the Middle Ages, which involved combining three individually legal

Contracts in order to produce a transaction of an interest bearing loan (something that the Church made

Illegal).

Bai' al-Inah (Sell and Buy Back Agreement)

The financier sells an asset to the customer on a deferred payment basis and then the asset is immediately

repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume

ownership over the asset in order to protect against default without explicitly charging interest in the event of

Late payments or insolvency.

Hibah (Gift)

This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah usually arises in practice

when Islamic banks voluntarily pay their customers interest on savings account balances.

Takaful (Islamic Insurance)

In modern business, one of the ways to reduce the risk of loss due to misfortunes is through insurance. The

basic idea behind insurance is the sharing of risk. The concept of insurance where resources are pooled to help the needy does not contradict Sharia'a.

Conventional insurance involves the elements of uncertainty (Al-gharar) in the contract of insurance,

gambling (Al-maisir) as the consequences of the presence of uncertainty and interest (Al-riba) in the investment activities of the conventional insurance companies which contravene the rules of Sharia'a. It is

generally accepted by Muslim Jurists that the operation of conventional insurance does not conform to the

rules and requirements of Sharia'a.

Takaful is an alternative form of cover which a Muslim can avail himself against the risk of loss due to

misfortunes. The concept of (takaful) is not a new concept; in fact it had been practiced by the Muhajrin of

Mecca and the Ansar of Medina following the hijra of the Prophet over 1400 years ago.

Takaful is based on the idea that what is uncertain with respect to an individual may cease to be uncertain

with respect to a very large number of similar individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of large numbers.

Sukouk (Islamic Bonds )

Islamic Equity Funds

Islamic investment equity funds market is one of the fastest growing sectors within the Islamic financial

system. Currently there are approximately 100 Islamic equity funds worldwide. The total assets managed through these funds currently exceed US$5 billion and is growing by 12-15% per annum.

With the continuous interest in the Islamic financial system, there are positive signs that more funds will be launched.

Some western majors have just joined the fray or are thinking of launching similar Islamic equity products.

Despite these successes, this market has seen a record of poor marketing as emphasis is on products and not

on addressing the needs of investors.

Over the last few years, quite a number of funds have closed down.

Most of the funds tend to target high net worth individuals and corporate institutions, minimum investments

ranging from US$50,000 to as high as US$1,000,000.

Target markets for Islamic funds vary; some cater for their local markets e.g.

Malaysia and Gulf based investment funds. Others clearly target the Middle East and Gulf regions, neglecting local markets and have been accused of failing to serve Muslim communities.

Since the launch of Islamic equity funds in the early 90's, we have seen the establishment of credible equity

benchmarks by Dow Jones Islamic market index and the FTSE Global Islamic Index Series. The website

failaka.com monitors the performance of Islamic equity funds and provide a comprehensive list of the Islamic

funds worldwide.

Islamic laws on trading

The Qur'an prohibits gambling (games of chance involving money). The hadith literature, in addition to

prohibiting gambling (games of chance), also prohibits bayu al-gharar (trading in risk, where the Arabic word

gharar is taken to mean "risk").

The Hanafi madhab (legal school) in Islam defines gharar as "that whose consequences are hidden." The

Shafi legal school defined gharar as "that whose nature and consequences are hidden" or "that which admits

two possibilities, with the less desirable one being more likely." The Hanbali school defined it as "that whose

consequences are unknown" or "that which is undeliverable, whether it exists or not." Ibn Hazm of the Zahiri

school wrote, " gharar is where the buyer does not know what he bought, or the seller does not know what he

sold.” The modern scholar of Islam, Professor Mustafa Al-Zarqa wrote that, "gharar is the sale of probable

items whose existence or characteristics are not certain, due to the risky nature which makes the trade similar

to gambling". There are a number of hadith forbid trading in gharar (risk), often giving specific examples of gharhar transactions (e.g. selling "the birds in the sky or the fish in the water", "the catch of the diver", "an

unborn calf in its mother's womb", "the sperm and/or unfertilized eggs of camels", etc.). Jurists have sought many complete definitions of the term. They also came up with the concept of yasir (minor risk); a financial transaction with a minor risk is deemed to be halal (permissible) while trading in non-minor risk ( bayu alghasar ) is deemed to be haram

What gharar is, exactly, was never fully decided upon by the Muslim jurists. This was mainly due to the

Complication of having to decide what is and is not a "minor risk." Derivatives instruments (such as stock options) have only become common relatively recently. Some Islamic banks do provide brokerage services for stock trading and perhaps even for derivatives trading.

MURABAHA

Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit.

Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him.

The bank does that for a definite profit over the cost, which is stipulated in advance.

IJARAH

Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.

IJARAH-WAL-IQTINA

A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

MUSAWAMAH

Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged

An advertisement for Bakht Account, to reveal his cost. Both the parties negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.

ISTISNA A

It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance future delivery or a future payment and future delivery. Istisna'a can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and

Highways.

BAI MUAJJAL Literally it means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of Murabaha Muajjal.

It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.

MUDARABAH

A form of partnership where one party provides the funds while the other provides expertise and management.

The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a preagreed basis, while loss is borne only by the provider of the capital.

MUSHARAKAH

Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners

in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.

BAI SALAM

Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver currencies. Barring this, Bai? Salam covers almost everything, which is capable of being definitely described as to quantity, quality and workmanship.