Islamic banking has developed recently. Put forward to be having high ethical criterions, the banking system upraises questions from many. First of all, we should answer some questions like that in this field. Are these standards just a sham —a smart way to hide that Islamic banks are basically like any other? Are they a real attempt to reunite religious principles with finance in a capitalist world?
To answer if Islamic banking is totally different from the conventional banking system, we should know the history of this interest-free banking system.
Origin of Islamic banking
The most important property of Islamic banking is its banning of interest. Doing business without the use of interest-bearing loans, in the form of Mudaraba rules, advances the coming of Islam.
Before Islamic period, Arabs in Mecca, close to the crossroad of old commerce routes, coordinated caravans to carry goods between Syria and Yemen. The Meccan merchants sometimes used agents to deliver the goods, buy, sell and report back with the numbers for profit or loss. Later on, it was shared according to the traditional principles of Mudaraba.
When a merchant united with others in a shared trading initiative, the profits or losses were shared, under an another principle called Musharaka, suitable for an agreement between participating sharers in a trade. Therefore, the trading caravans were capitalized with the principle of sharing profits or losses, not by interest-bearing loans.
Before modern banking system becomes popular, Mecca was a quite small town, and the forming a trade caravan was a principal occasion. The travelers and their patrons were acquainted with one another’s general fame and status, and possibly knew each other as a person. That continued true of societies in the early Muslim period.
But, society is more disunited in today’s world. Rich people to invest do not need to know anybody with an initiative that requires capitalizing, and people who have trade thoughts may have no contact with possible investors.
The conventional banking system has grown up to intercede between the groups of people, enterprisers and investors. To exist, the banks obviously have to make a profit.
Prohibition on interest
The prohibition of interest (riba) on loans in Islamic banking system is well known. Riba is considered as haram, or forbidden in Islam. But to operate a bank needs to charge some fees for its services. For conventional banks, a principal of profit is from revenue that is obtained from charging interest.
In contrast, Islamic banks make their profits in other ways such as ‘profit-sharing’. Is it possible for Islamic principles of profit-sharing rather than interest taking to transfer from the trading caravans to the anonymous banking system that we experience now?
The old systems of Musharaka and Mudaraba survive in the modern Islamic banking system. They both refer to ways of sharing risk and reward in place of remuneration at a fixed interest rate.
Mudaraba is used for a more passive kind of investment or participating, in which one side supplies capital or goods, and the other side carries out the work necessary to gain a profit.
Musharaka presents a more active investment style by a person who is either a partner in the business or a supplier of money.
A very distinct difference of the Islamic banking system over conventional banks is on the sharing of risk, that is equally spread to either the lender or borrower.