. Islamic banking, and it’s distinguishing principles.

By

Abbas Abdullahi

March, 2022.

1
R
 Chapter one

1.1 Introduction

1.2 Concept of Islamic Banking

1.3 When, Where and How Islamic Banking Started in the World
1.4 Development of Islamic Banking

Chapter Two
2.1 Fundamental Features of Islamic Banking
2.1.1 Mudaraba (Silent Partnership)

2.1.2 Murabaha (Mark Up)

2.1.3 Musharakah (full Partnership)

2.1.4 Ijarah(Leasing)

2.1.5 Bay’u Salam /Salaf(Purchase with deferred delivery)

2.1.6 Bay’u Mu’ajjal (Purchases with Deferred Payments)

2.1.7 Jo’alah (Service Charge)

2
R
 2.1.8 Muzara’ah (Tradisional counterpart of Mudaraba contract in farming)

2.1.9 Bay’u wal Ashira’u (Direct investment)

2.2 Distinguishing principles of Islamic Banking System

2.2.1 Interest Free / Free From Riba (Usury )

2.2.2 Gharar (Uncertainty)

2.2.3 Profit and Loss Sharing (PLS)

2.2.4 Sanctity of Contract

2.2.5 Unlawful Goods And Services.

2.2.6 Money Does Not Creates Money

2.2.7 Loan

Chapter three

3.1 Challenges Facing Islamic Banking .

3.1.1 Islamic Banking Concept

3.1.2 PLS Concept

3
R
 3.1.3 Shortage of Experts in Islamic Banking

1.4 Misconception About Islamic Banking Operations

3.1.5 Lack Up Proper Knowledge Of Islamic Shariah.

Conclusion

Bibliography

Chapter one

1.1 Introduction

Islamic religion is the only divine religion on the Surface of Earth that covers all
spheres of life, nothing leave without a vivid explanation on the areas of life as far
as human life is concern, Allah says : “We have not neglected in the book a thing” 1
Based on that, Islamic religion under the provisions of Quran and Hadith provides
the most Just and equipped system of finance, therefore, one of it’s components is
Islamic banking. The Islamic banking is a financial activities or product
mainly implemented to comply with the main guides of Shari'ah (or Islamic
law). Along the line, Islamic banking can be described as finance under
Islamic law In turn, the main sources of Islamic banking are: the glorious
Quran, Hadith, fiqh, (jurisprudence) Ijma, Qiyas, history of Islamic government
as well as real life data which did not contradict Quran and sunnah. Islamic
finance is based on ethical principles in line with Islamic religious law.

1.2 Concept of Islamic Banking

1
Quran 6:38
4
R
1.1 Islamic banking is the system that has to do with financial business that is not
contradicting the provisions of Islam 2 in another sense, Islamic banking is seen
as banking system which is consonance with the ethos, spirit, and value system
3
of Islam governed by the principles laid down by Islamic Shariah Also
Islamic banking is defined as a banking activity that is consistent with the
principles of Shariah 4
1.3 When, Where and How Islamic Banking Started in the World

The first International conference on Islamic economics in Mecca (1970) and

International economic conference in London (1977) were the reason that brought
about Islamic banking initiation in the World 5 the first Islamic banking system can
6
be traced to the establishment of the Mit Ghamr savings bank in egypt in 1963
Around the same time with the establishment of Mit Ghamr, Islamic financial
institutions were also began in Malaysia. In September 1963, Perbadanan Wang
Simpanan Bakal-Bakal Haji (PWSBH) was established . It was the first Islamic
banking in Malaysia which established to assist Muslims to save their Haji
expenses. 7

1.4Development of Islamic Banking

Now Islamic banking system is practiced in more than 50 countries globally, 8 such
as Republic of Iran, Pakistan, Sudan, Malaysia all Banks and financial institutions
have adopted Islamic banking principles since 1980s countries like, Jordan,
Indonesia, Bangladesh, and Egypt are in Islamic banking system, but still practice
9
conventional system of banking not all countries where Islamic financial

2
Chistie Moinuddin(2018)
3
Imra
4
Olanipekun & Brimah & Ajagbe(2015)
5
Ibid
6
Ibid
7
Nur, monica & low soon (2016)
8
Olanipekun & Brimah & Ajagbe(2015)
9
Luca & mitra 1998
5
R
institutions are functioning include: Albania, Algeria, Australia Bahamas,
Canada, Iraq, Italy, Ivory cost, Kuwait, Morocco, Netherland, Niger,
Palestine, Qatar, Russia, Saudi Arabia, Senegal, South Africa, Switzerland,
Tunisia, Turkey, Dubai, United Kingdom, and United States of America 10
since 2015 there were more than 180 Islamic Banks and financial institutions in
Asia, Africa, Europe and USA with more than 8000 branches in the world 11

In Nigeria, the first recorded attempt at establishing a Non-interest bank

was in 2004 when the CBN under the leadership of Soludo granted an
Approval-in-Principle License to Jaiz Bank PLC to carry on business as a
Profit and Loss Sharing Bank. This was followed with the CBN Governor
(Sanusi Lamido Sanusi) announcement on Monday, June 20, 2011, at a
Conference on Islamic Banking in Dakar, Senegal, that it had issued Jaiz
International Bank PLC an Approval-in-Principle as the first Islamic Bank 12

Chapter Two

2.1 Fundamental Features of Islamic Banking

The Fundamental features of Islamic Banking system are the operating keys of
Islamic banking, and can be seen as the instruments of non interest banking, along
the line, these instruments are the distinguishing features with conventional system
of banking. In a nutshell, the following are some of the financial instruments of the
13
Islamic banking system : Mudaraba, murahabah, musharakah, Ijarah, bay’salam,
same in 14 Muzara’ah, Direct investment, Jo’alah,, Bai’mu’ajjal 15
10
Olanipekun & Brimah & Ajagbe(2015)
11
Ibid

12
Ibid

13
Olanipekun & Brimah & Ajagbe(2015)

14
Mahmood Amin( 2000)
15
Luca & mitra 1998

6
R
2.1.1 Mudaraba. 16Mudaraba is a( trustee financial contract,) it’s Also known as
17
(Silent partnership) is a system of contract where the bank would provide the
capital needed in the project, while the entrepreneur would render the services and
expertise based on his experience, the profit and losses would be shared between
the two parties on an agreed ratio, the bank will bear the financial losses while the
enterprenuer would lost his time and effort,18 unless if negligence or
mismanagement is proven by the entrepreneur.

Deposits made to the bank by individuals under a Mudarabah contract are treated
as an investment in the bank by the individual. The bank will use this investment
to help make profits from its trading activities i.e. financing of individuals and
businessmen. Under the Mudarabah contract the bank will have agreed to give the
depositor a share of its profits in return for the investment based on a pre-agreed
ratio.19 The same as the first party may collect some capital from the second party
and invest, in the end, profit gained should be distributed depending on their
agreement, the capital must not be owned completely by the second party.
Evidence Of it’s legality is the hadith of Ruwayfi' said: Any one of us would
borrow a camel during the lifetime of the Prophet s.A.w) from the other, on
condition that he would give him half the booty, and the other half he would retain
himself.20

2.1.2 Murabahah (Mark up) is a contract that is based on a mark-up (or cost
plus) principle, in which a bank would buy goods for a customer and resell
them to the customer , 21 is Just like buy and sell business, normal trading
between bank and the customers, Murabahah involves identification of
16
A. Abdulmuhsin (1430 A. H/2009)p.g 85.
17
Mahmood Amin (2000)
18
Ibid
19
Chistie Moinuddin(2018)

20
Ahmad (16380)
21
Olanipekun & Brimah & Ajagbe(2015)

7
R
particular goods by a customer for the bank to secure for him; the bank
will add the mark-up profit, deliver the goods and collect the payment from
22
the customer in deferred terms, it may be deducted bid by bid from the salary
of the customer, this is when the customer uses the bank as his salary account.

Also A murabahah contract refers to a cost plus mark-up transaction between the
parties. Under this contract a three party arrangement is made where the customer
places an order with the bank to purchase goods from a supplier. The customer
may pay a security deposit with the bank and the amount of financing outstanding
can be secured either in the form of collateral or guarantee23

2.1.3 Musharakah (Equity participation contract)it’s also called (full partnership)

24
In this type of contract, the bank is not sole provider of the capital, two or more
25
partners Contribute to the joint capital for the investment Musharakah can be
seen also and a joint venture in which a bank and an entrepreneur jointly
contribute capital and manage a business project. Any profit-and-loss from
the project is shared in a pre-determined manner.26

Evidence of it’s legality is the saying of Allah (SWT) “And indeed, many
associates oppress one another, except for those who believe and do righteous
deeds”27 and the Hadith of Abu Hurairah The Messenger of Allah () having said:
Allah, Most High, says: "I make a third with two partners as long as one of them
does not cheat the other, but when he cheats him, I depart from them."28

2.1.4 Ijarah (leasing ) Ijarah is an Islamic mode of banking in which Islamic Bank
buys the financed object, and retains the ownership during the life of the contract.
22
Ibid
23
Chistie Moinuddin(2018)

24
Mahmood Amin (2000)
25
Luca&mitra 1998
26
Olanipekun & Brimah & Ajagbe(2015)

27
Quran 38:24
28
Abu dawood (3383) da’eef according to Albani
8
R
The customer makes a series of lease payments over a specified period of time, and
may have the option at the end to buy the item from the lessor (the bank) at a pre-
specified residual value. 29Evidence of it’s legality Allah says : “One of the women
said, "O my father, hire him. Indeed, the best one you can hire is the strong and the
trustworthy."30in the Hadith the prophet (S. A. W) says :”Give the hired his reward
Before his wet get dried “31

2.1.5 Bay’u Salam /Salaf (purchase with deferred delivery) is a system of finance
whereby the seller sells a product before it’s season, but the money would be
collected , i.e. the buyer pays the seller full amount of the product agreed, the seller
would promise to deliver it in the future, such a contract is only made on a product
32
that the quantity and quality May be fully specified, usually agricultural product
in this contract both of the contracting parties would benefit, the seller might not
have the capital to invest during the contract, and the buyer would also benefit with
price of the product at the time of harvest . evidence Of it’s legality is the hadith Of
Abdullahi Bn Abbas reported that when the Messenger of Allah (may Allah's
peace and blessings be upon him) came to Madinah, they used to pay one, two or
three years in advance for fruits, so he said: "Whoever pays in advance for
anything, let him pay for a specified measure and a specified weight, to be
delivered on a specified period of time."33

2.1.6 Bay’u Mu’ajjal (purchase with deferred payment) The bank sells a product
on a deferred payment, usually on instalment, the price of the product is agreed
between the bank and the buyer at the time of the sale, and the bank cannot earn
any charge incase of deferring payment. 34Evidence Of it’s legality is the general

29
Mahmood Amin 2000
30
Quran 28:26
31
Ibnu majah (2443)
32
Luca&mitra 1998
33
Bukhari (2239) Muslim(1604)
34
Ibid
9
R
saying Of Allah (S. W. T) “O you who have believed, when you contract a debt for
a specified term, write it down…”35

36
2.1.7 Jo’alah (Service Charge) As it’s well known in conventional banking
system, that the bank charges some amount in return of their services rendered to
the customer, depending on the mode of service offered to the customer. Evidence
Of it’s legality Allah says:

“They said, "We are missing the measure of the king. And for he who produces it is
[the reward of] a camel's load, and I am responsible for it."37

And in the Hadith of Abu Sa’id Alkhudry, Reported in the long Hadith of
companions Who recited fatihah to the chief of the Village Who was stung by
scorpion,… the prophet said to them after collecting the agreed price of their
services.. "You have done the right thing. Divide (what you have earned) and
assign a share for me as well."38

2.1.8 Muzara’ah 39(Traditional counterpart of Mudaraba contract in farming) In

this type of contract, the harvest would be shared between the bank and an the
entrepreneur.

Evidence Of it’s legality is the hadith of Ibn Umar (Allah be pleased with them)
reported that Allah's Messenger (may peace be upon him) contracted with the
people of Khaibar the (trees) on the condition that he would have half the produce
in fruits and harvest40

2.1.9 Bay’u wal Ashira’u (Direct investment) this could be any type of lawful
trade in Islamic Shariah, with the exception of prohibited transactions.
35
Qur’an2:282
36
Luca&mitra 1998)
37
Qur’an12:72
38
Bukhari (2276)muslim (2201)
39
Ibid
40
Bukhari (2329) Muslim (1551)
10
R
Evidence of it’s legality is the saying of Allah (SWT) ." But Allah has permitted
trade and has forbidden interest.” 41

2.2 Distinguishing Principles of Islamic Banking System

The distinguishing features of Islamic Banking are also the features of Islamic
banking system, which differentiate it to the conventional banking system. Some of
the principles are as follows:

2.2.1 Interest Free / Free From Riba (Usury ) Islamic banking cannot be
considered as a similitude or replica of conventional banking. Because the most
important principle of conventional banking is that money creates money, or
generates money on it’s own, known as interest or usury. 42 This practice (known in
Arabic as Riba) is contrary to the principles of Islamic finance, initially , Islamic
law has broadly detest it. Money has never been considered as a commodity that is
as worth as generating money, but , Islamic law categorically sees money as a
medium of exchange.

Evidence of it’s prohibition, Allah (S. W. T) says : “But Allah has permitted trade
and has forbidden interest”43 And in the Hadith of Jabir Bn Abdullah, The prophet
said, Allah has cursed one Who deals with usury, either eating, writing or serving
as a witness over contract. 44

2.2.2 Gharar (Uncertainty)

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. 45 Many
examples of Gharar were given in vivid in a number of prophetic Ahadith . They

41
Quran 2:275
42
Chistie Moinuddin(2018)
43
Quran 2:275
44
Muslim 1598
45
Mahmood Amin( 2000)

11
R
include: the sale of fish in the sea, birds in the sky, an unborn camel in its mother’s
womb, a runaway animal, the semen and unfertilized eggs of animals, 46 un-ripened
fruits47 on the tree, etc.48 All these aforementioned examples are uncertain and they
may or might not exist. Islamic banking system is practically out of any business
that has to do with Gharar unlike conventional banking system that deals with
gambling in some instances.

General prohibition came in the Hadith of Abu Huraira that the prophet (S. A. W)
forbids sells of pebbles and the sells of Gharar (uncertainty) 49

2.2.3 Profit and Loss Sharing (PLS) there is no predetermined rate of interest in
Islamic finance. Rate of return depends upon the actual market condition in the
particular market economy. In Islamic finance, risk is shared and not transferred
on the barrower or entrepreneur.50 Unlike conventional banking system where
interest are being charged even in the case of organization suffers losses by using
Bank’s fund, it’s not based on PLS.

Evidence of it’s legislation is the Hadith of Abu Huraira, the prophet (S. A. W) “…
it’s reward for Him and it’s loss on Him”51

2.2.4 Sanctity of Contract . Before executing any Islamic banking transaction, the
clients have to satisfy whether the transaction is halal (valid) in the provisions of
Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or
voidable.

2.2.5 Unlawful Goods And Services.

46
Bukhari 2284 muslim 1565
47
Bukhari 1488 Muslim 1555
48
A. Albassam pg. 266,267
49
Muslim 1513
50
Fayaz & siraj (2017)

51
Daruqudni (303)Baihaqee (6/39)
12
R
Along the line, another important distinguishing feature is that Islamic banks are
not involved in any activities concerning unlawful goods and services. These
prohibited goods and services include: any prohibited foods such as pork,
un-slaughtered animals52 or animals which were not slaughtered according to
Islamic provisions53, intoxicants54, and pornographic visuals. Non-involvement is
not only limited to buying or selling but also includes all forms of production and
distribution, such as the packaging, transportation, and marketing of these
prohibited goods and services55 must especially in the case of intoxicants, where
almost ten characters were cursed by Allah, the prophet (S. A.W) said" Allah has
cursed wine, its drinker, its server, its seller, its buyer, its presser, the one for
whom it is pressed, the one who conveys it, and the one to whom it is conveyed” 56

2.2.6 Money Does Not Creates Money . In Islamic banking, profit is earned
through trade by carefully managing risk taking, work and effort, and
responsibility (daman). Thus, In Islamic banking, a contract is based on exchange
of money with an underlying commodity, while as in conventional banking,
contract is based on exchange of money with money (interest) 57as it’s illustrated
in the previous pages,

2.2.7 Loan. Islamic banks do not offer cash loans; rather, they grant
facilities based on either Islamic contracts with uncertain returns, such as
participation (Musharakah), Mudarabah, Muzaraah, or contracts with certain
returns, such as Murabahah, sale on installments, the bank purchases
merchandise for customers and sells it to them cash or gradual payments with
an agreed profit.58

52
Qur’an:2/173
53
Qur’an:6:121
54
Qur’an:5/90
55
Chistie Moinuddin(2018)
56
Abi Dawud 3674 Authenticated by Albani, sahih Abu dawuda (3647)
57
Fayaz & siraj (2017)
58
Akbar & farhad (2018)
13
R
 Chapter three

3.1 Challenges Facing Islamic Banking .

There are a number of Challenges facing Islamic banking system in almost every
community, this is because, Islamic banking is developed as a second chance after
conventional banking system, ignorance of the actual concept of Shari’ah in fiqh of
transaction, and discrimination as well. some of the challenges are as follows:

3.1.1 Islamic Banking Concept: In the absence of Islamic banking laws, the
enforcement of it in courts may require extra efforts and costs. Therefore,
banking and companies’ laws in several countries, most especially non Islamic
countries, require palpable attention to provide a room for Islamic banks.
Furthermore, international acceptance of Islamic financial contracts requires
them to be Shariah compatible as well as acceptable under the major legal
systems such as Common law and Civil law systems.59

3.1.2 PLS Concept : Deposits in Islamic banks are usually based on principle
of profit and loss (Musharaka or Murabaha). If something happens and the
bank suffers loss it has to be transferred to the depositor directly based on
his agreed ratio. This fear of loss is the biggest barrier to deposit motivation
in Islamic banks. In some cases, it leads to withdrawal of funds60

3.1.3 Shortage of Experts in Islamic Banking : The supply of trained or

experienced bankers has lagged behind the expansion of Islamic banking. 61 A
step forward needs an immediate effect in order to tackle the Challenge in
question, this is by training a number of Islamic bankers with zeal and prior
experience of Islamic law of transactions.

59
S.N Kinyanjui(2013)

60
S.N Kinyanjui(2013)
61
Ibid
14
R
3.1.4 Misconception About Islamic Banking Operations . Some people
misunderstand the actual concept of Islamic banking system , they thought that
Islamic banks are only for Muslims. 62 Even through, Islamic banking are in
accordance to Shariah Law, it is not only applicable for Muslims. Surprisingly, the
higher shareholder in Jaiz bank PLC is non Muslim, could you emerging, had it
been is only restricted to Muslims he wouldn’t have gotten this opportunity.

3.1.5 Lack Up Proper Knowledge Of Islamic Shariah. Many Muslims are not
conversant with the Shari’ah goals, hence, they Lack orientation of how Islamic
banking operates, this leads even Muslims not to open accounts in it, which leads
to the major Challenge facing Islamic banks in Nigeria, i.e. Lack up sufficient
customers.

Conclusion

With reference to the previous illustrations, a reader would come to an

unconquerable fact that Islamic banking system is the financial system that
carries all parties along and meet the needs of all and sundry, irrespective of
the location, time and influence, and also a reader would understand that
Islamic banking encompasses all forms of finance, Islamic investments,
creative and progressive financial activities, such as trade, leasing,
mortgage, silent and full partnership agriculture and other real estate
financing services, all in accordance to the teachings of Islamic Shariah.

62
Nur, monica & low soon (2016)
15
R
 Bibliography
 Al-Qur'anil Kareem, (2016)Saheeh International Translation.Dar
Qira'aat
 Muhammad Bn Isma'il, Al-Bukhari, Jami'u al-Musnadu al-Sahih.
 Muslim Bn Al-Hajjaj, Al-Musnadus Sahihul Mukhtasaru Minas
Sunani Binaqlil ‘Adli ‘Anil ‘Adli ‘An Rasulillahi Sallallahu ‘Alayhi
Wa Sallam.
 Olanipekun & Brimah & Ajagbe(2015) ISLAMIC BANKING AND
FINANCE EVOLUTION: A PANACEA FOR SUSTAINABLE
16
R
 DEVELOPMENT IN NIGERIA(International Journal of
Accounting Research Vol. 2, No. 5, 2015)
 Muhmood Amin (2000) A Basic Guide to Contemporary Islamic
Banking and Finance, Rice University.
 Luca & mitra (1998) Islamic banking, issues in prudential regulations
and supervision (International monetary fund)
 Chistie Moinuddin(2018) An introduction to Islamic Finance A
different perspective on global business(CIMA)
 Nur, monica & low soon (2016) CHALLENGES AND
OPPORTUNITIES OF ISLAMIC BANKING AND FINANCIAL
INSTITUTIONS IN MALAYSIA.( South East Asia Journal of
Contemporary Business, Economics and Law, Vol. 10, Issue1(Aug.)
ISSN 2289-1560
 N Kinyanjui(2013) Challenges Facing the Development of Islamic
Banking. Lessons from the Kenyan Experience(European Journal
of Business and Management
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online) Vol.5, No.22,
 Fayaz Ahmad Lone and Siraj Ahmad (2017). Islamic finance:
more expectations and less disappointment. Investment
Management and Financial Innovations, 14(1), 134-141.
doi:10.21511/imfi.14(1).2017.14

 Akbar & farhad (2018) AN OVERVIEW OF ISLAMIC BANKING

AND FINANCE IN ASIA(Asian Development Bank Institut)

 A. Abdulmuhsin (1430 A. H/2009)Iqtisadul Islamiy) Mu’assasatul

jarisi wattauzi’I (Riyad)
 A.A. Albassam (Taudihul ahkam min bulugul Maram) Maktabatul
wa’di, Makkatul mukarramah.
 Sunan Abi Dawwod
17
R
  Musnad Ahmad
 Sunan daruqudni

18
R