What is Islamic Banking?
Islamic Banking refers to banking and financial services based on the principles of Shariah, which importantly prohibit the payment or acceptance of interest ("Riba") stemming from the fact that money is perceived only as a medium of exchange, storage value and unit of measurement and NOT as a commodity. Additionally, investment in businesses that deal with goods and services that are considered sinful ("Haram") is also prohibited.
Major Approaches for Islamic Banking Deposit Accounts
In conventional banking as we know it, the relationship between a bank and a customer is that of a debtor and a creditor, namely: the bank earns profit by charging interest to borrowers of funds, and using money it earns to pay back to depositors of funds as interest. Because Islamic Banking considers the payment or receipt of interest ("Riba") as an act of sin, the relationship between an Islamic bank and its customer takes on a different form. Here are some of the common arrangements when you deposit your money into an Islamic Banking account:
Mudharabah: This is a partnership arrangement where one party gives money to another to invest in a business venture. Profit from the project is seen as being "shared" between the two parties based on a percentages agreed upon in advance. Say you deposit money into an Islamic bank, you are then seen as the provider of funds that enable the bank to undertake investment endeavours, to which the resulting profits are then shared back to you on pre-agreed profit-sharing ratio.
Wadiah: In this arrangement, the bank is seen as a party entrusted to safe-keep funds deposited by bank customers. Subsequently, the bank offers gifts ("Hibah") back to the customers usually representing a portion of the profit made using the deposited funds. Technically, Hibah is akin to the interest you earn from your deposits in Conventional Banking; but in principle, it is not, because Hibah is a voluntary payment made at the bank's discretion and is not guaranteed.
Murabahah: This refers to the sale of goods from one party to another at a profit mark-up agreed upon by both parties. Say you put money into a fixed deposit account, the bank then uses your funds to engage in the buying and selling of Shariah-compliant commodities using the Murabahah principle then returns the principal amount plus profit back to you on deferred payment basis. Both parties know the cost of the commodity and the profit at the onset, so there's no financial uncertainty in the transaction.
What All This Means to Bank Customers
Still finding it too hard to understand? Undoubtedly, Islamic Banking is a complex financial system that many might find demanding to decipher. For the general public, all you need to know is that the difference between Conventional Banking and Islamic Banking lies in the principles powering the banking system and not so much the end-results, so everything you knew about banking pretty much still applies, namely:
- If you deposit money into a bank, you will most probably end up with more money over time.
- If you borrow money from a bank, you will most probably end up needing to pay more money back to the bank over time
Regardless of your choice, your benefits and obligations as depositor or borrower remain the same. And ultimately, that's really what matters for bank customers.