If the six basic morals narrated in the last two articles are embraced by the merchants of this world – no matter how big or small they may be in size – will it not address greed, exploitation, dishonesty, false pretence, superfluous disputes, profiteering, black-marketing and above all, abject poverty? Isn’t it a point to ponder?
After having seen the noble cause of Shariah compliant trading, the stage has come where we enter the Islamic banking landscape. A number of people I met from different parts of the world in my Islamic banking and finance career were mystified as to how Islamic banks make money if they do not, at all, deal with interest. And most of the time, the next predictable question is why Islamic banks do not deal with interest when actually they are categorized as ‘banks’.
While the illustration to the first question will be rolled out starting from this article, there is an interesting prevalence about the second. I have learned from authentic sources that when the world’s first commercial Islamic bank, the Dubai Islamic Bank, was launched in Dubai in 1975, it was easy to come up with the first two parts in the name of the bank such as Dubai – since it was Dubai where the idea was conceived – and Islamic, as the modus operandi of the new institution was to be based on Shariah principles. However, the debate was on how to narrate the nature of the institution so as to let the people know that, in addition to conventional banks, this too is a place where they can deposit their funds.
Finally, it was agreed to call it a ‘bank’, in line with the conventional banks operating in the country at the time so that the message gets across that the new institution will also accept cash deposits, similar to conventional banks. The commonality between the new Islamic bank and the existing conventional banks ended there with the word ‘bank’. This seemed to have paved the way for the other Gulf countries which saw the emergence of Islamic banks, some without using the word ‘bank’ such as Kuwait Finance House. Recently, Emirates Islamic Bank in the UAE also rebranded itself simply as Emirates Islamic by shortening its name without using the word ‘bank’.
The explanation of the modus operandi of an Islamic bank in detail convinces enquirers that it is a commercially viable, legally enforceable and Shariah compliant way of making money. Nevertheless, it is a time-consuming and strenuous exercise and as such, the initiative by Islamic Finance news to educate readers on Islamic banking and finance is a step in the right direction. Once completed, this series can be referred to while trying to clear the confusion.
When the regulatory authority of a certain jurisdiction grants a license to the founding shareholders of a conventional bank, one of the license conditions is that the depositors’ funds obtained on interest must not be used for trading purposes but only for lending on interest. Similarly, when the apex body of a country issues an Islamic banking license, it confines the shareholders from borrowing or lending the money on interest but allows them to utilize customers’ funds for trading and investment purposes only.
An Islamic bank’s objective for trade and investment is served through various contracts: some of them are categorized as sale contracts and others are called investment contracts. While in Shariah there are scores of sale contracts and a number of investment contracts, we shall limit our discussion to the commonly known sale and investment contracts which are in use by almost all Islamic banks and financial institutions operating around the globe.
Nonetheless, before proceeding in that direction, readers will find it interesting to learn that conventional banks actually use only a single structure around which the entire banking products are built, that is lending on interest. As such, all retail and corporate banking products offered by conventional banks use the single structure of interest-based lending.
Contrary to that, Islamic banks and financial institutions have an array of structures that are suitable for a particular situation or need of a customer. And then there are hybrid configurations by combining any two or more structures to suit the client’s funding needs. As the scholars say, unlike conventional banks, one size does not fit all situations in Islamic banks.
So what are these structures? They are divided into two categories: sale contracts and investment contracts. The main sale contracts commonly used by Islamic banks worldwide are Murabahah, Salam, Istisnah and Ijarah whereas the investment contracts are Mudarabah, Musharakah and Wakalah.
How to distinguish between these two types of contracts? The core aspect that differentiates them is that when entering into a sale contract, the seller comes to know the extent of the profit (or loss) it is making while in the case of investment contracts, the end result is known upon the completion of the investment period for which the contract was entered into.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next Week: Explanation of Murabahah contracts to continue.