Islamic Banking

What is Islamic Banking?

At the heart of Islamic banking is the belief that compound interest or Riba is banned, rather all financial and commercial dealings are based on the principal of profit and loss sharing.

Islam concedes the right of private ownership, in fact it considers it essential for the needs of human life. Thus the individual has the right to own everything he needs, provided that he does not over ride that of others.  In this case possession becomes the collective type.

Collective ownership does exist in Islamic economies and is not opposed or contradictory to private ownership.  For the individual, ownership is truly self created right which has a social function.  In Islam the owner's self created authority is not threatened with regards to what he owns but one must reconcile the private interest with that of society.  When there is a contradiction between the private interest and society then the society should prevail.

In Islamic teaching, whether ownership is collective, individual or of a state type, the original owner is Allah. The individual or state are no more than successors who benefit from this ownership.

The Islamic economic system shuns the idea of concentrating wealth in the hands of a minority, whilst others less fortunate exist within society. Therefore, a number of laws have been issued to avoid this problem. Among these laws and regulations which Islam introduces are alms (zakat) coinheritance, charity, extravagance and over expenditure.

What is the History of Islamic Banking?

For centuries Muslim communities have practiced a number of credit methods and financial techniques. These methods made up a prevailing informal credit system which animated the international commerce of the area extending from the Middle East to Southern Europe three or four centuries before the emergence of any comparable phenomenon in Europe.

By the 8th century, a number of credit institutions had in fact evolved and the role and function of credit in commerce and in the various aspects of the economy were understood and documented. Credit methods capable of facilitating commerce and of providing a framework to use credit as a means of investment featured quite prominently in the early Islamic legal texts.  Furthermore, the development of banking and quasi banking activities in Iraq in the 10th century was recorded.

Islamic countries used a fairly complex banking system which involved instruments of credit and loans such as hawala (payment of debt through the transfer of a claim) and suftaja (equivalent to a letter of credit or bill of exchange).  It also involved exchange transactions and the use of ruqas (similar to modern day cheques) and was marked by the existence of certain forms of credit based commercial association such as capital trust financing (Mudaraba) and partnership (Musharkaka). This system was flourishing in the Muslim world several centuries before some of these financial instruments appeared in Europe.

What is the Difference Between Islamic Banking and Conventional Banking?

Like other institutions, Al Rajhi Bank aims to obtain returns by serving society with products and services.  However, the basic framework for Islamic banking at Al Rajhi Bank lies in the Sharia.  The Sharia is a set of rules and laws, which govern economic, social, political and cultural aspects of the society.

There are a number of fundamentals, which are at the heart of how Al Rajhi Bank operates:

  • Dependence on Sharia

    The practices of the bank are governed by Sharia laws.  As a result all of the products and services are delivered in the context of Islamic teachings with a focus on work ethics, wealth distribution and social and economic justice.
  • Prohibition of Ribah

    The probibition of ribah is the fundamental basis of all dealing between people, whether individually or intentionally.  The prohibition, includes all kinds of and means of ribah, regardless of the name, shape or ration.  Instead of riba, Islamic teachings have permitted trade as a method to deal and means of subsistence.
  • Source of Increase of Money is Effort and Labour

    Money is not the source of wealth creation and also that money should not create money.  Work and effort, for example, intellectual effort must play a role in the productive process, in other words the development process must be achieved through an relationship between capital and labour. This does not mean however, that wealth gained without effort, such as gifts, inheritance or charity is disallowed.  These gains, in fact are not guaranteed and effort still has to be made in order to manage these gains and guarantee a regular income.  Otherwise this wealth will be depleted through zakat. Therefore who ever makes an effort deserves a reward for it and is entitled to get it.  Conversely, people who do not make this effort should not expect any return and are not entitled to it.  Exception is made for people who cannot work because of illness or disability.
  • Risk Sharing

    the risk in any financial transaction is shared between the individual and the bank.  The objective is to ensure that a determined rate which occurs in a conventional bank whereby the entrepreneur takes all the risk, regardless of the result of the project.  In Islamic banking there is no unbroken gain or loss, it is not just for the same person to always be winning or losing.