February 22, 2013
This goal of this research is to find out if Islamic Banking is a better alternative to the Western, Conventional Banking. The information provided will reveal various Islamic Banking principles that would have prevented previous major economic crises and if applied globally today could prevent a major economic collapse.
Islamic Banking is banking system based on Shari'a (Islamic) Law on which it developed its unique characteristics that will be discussed in this paper. Shari'a Law does not allow the use of Interest (Riba), trading in financial risk, and investing in businesses that are considered unlawful according to the Quraan and Islamic scholars. Shari'a law in Islamic Banking is meant to promote economic and development through the means of disciplined investing, fair risk sharing, and profit or loss sharing (Warde, 2000).
The literature that will be examined in this paper will show that Islamic Banking is a good alternative to the current global banking system, however, it will be near impossible to revamp the existing banking system and replace it with Islamic Banking because it goes against many of the core principles of conventional banking that the global economy is built on which has been around for decades.
The main goal of Islamic banks was to promote social and economical welfare in society through guiding investors and offering financial assistance to businesses by engaging in profit sharing transactions (Warde, 2000). Islamic banks were thought of as more than just financial intermediaries and more like a partnership with every customer since the investments were based on profit and loss sharing which meant that the banks share the same risk as investors; this in turn made sure that Islamic banks were involved in low risk markets and practiced socially conscious investing that basically eliminated moral hazard problems.
“Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process. The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975” (Abdul Gafoor, 1995).
In 2007, the International Money Fund (IMF) stated that “there are currently more than 300 Islamic financial institutions spread over 51 countries, plus well over 250 mutual funds that comply with Islamic principles. And, over the past decade, the Islamic banking industry has experienced growth rates of 10-15 percent per year—a trend that is expected to continue” (Solé, 2007). This shows the increasing popularity of the Islamic Banking system and the potential market; in between 2008 and 2009, according to The Banker magazine, the “worldwide Sharia-compliant assets grew by 29% over the past year to $822 billion” (The Economist, 2009). Types of Financing
There are several ways that money can be generated in Islamic Banking. As stated earlier, these 'modes' of financing follow the basic principles of interest-free, and shared-risk investing. While this might sound odd to someone who is used to Conventional Banking, the literature discussed here will provide insight as to how money can be made on interest-free financial activities. It is important to note that in order for a financing activity to be considered permissible by Islam, it has to adhere to stated Shari'a law in the Quraan or to the consensus of leading Islamic scholars (Warde, 2000).
Musharakah is a partnership created on the basis of...