Islamic financial institutions

By on May 23, 2014
Image by Zahid Lilani

Islamic Finance remains a largely unknown concept even today in spite of being into existence since more than six decades now. The concept of Islamic finance has its roots from Islamic countries since the 1950’s and 1960’s. Kahf (2000) asserts that the roots of Islamic finance can be found in writings on Islamic economics dating back to 1940’s. These writings discussed interest-free banking and it finally led to the establishment of two Islamic banks in Egypt and Malaysia. Today, such banks and financial institutions can be found all across the world but these are mostly concentrated in the Muslim countries like Indonesia, Malaysia, Pakistan, Bahrain, Turkey and Kuwait etc.

What are the basic concepts underlying Islamic financial institutions?

The basic idea underlying an Islamic financial institution is that it is governed by the Islamic law known as ‘Sharia.’ Sharia is basically a set of rules and laws which had originated some 1400 years ago from the teachings of Quran and the explanations offered by Prophet Mohammad known as Sunnah. Sharia is an Arabic term which means “the way to the source of life” International Finance, 2013). Sharia guides various aspects of the Islamic societies including economic, political, social and cultural. Islamic law emphasizes upon justice and partnership in business. Thus, all the financial institutions which follow the Shariah laws come under the purview of Islamic finance (ACCA, 2011).

Unique features of Islamic financial institutions

While the basic function of Islamic financial institutions is in line with conventional non-Islamic financial institutions i.e. provision of financial services, these are required to conduct business within prescribed boundaries set by Shariah. There are a few peculiarities about Islamic financial institutions which make them different from conventional financial institutions:

  • No Interest: Interest which is called ‘Riba’ under Shariah is prohibited in Islam. No Islamic financial institution can charge interest on loans it provides and also cannot offer interest to its customers on the deposits made by them. The basic objective here is to eliminate the malpractices and exploitation usually conducted in the name of interest (ACCA, 2011).
  • Profit-sharing: As already stated that working on interest is completely prohibited in Islamic financial institutions, these institutions follow a profit or loss sharing model. Wherever the investments are made by these institutions, they share the profit or loss as the case may be (ACCA, 2011).
  • Prohibitions: Shariah prohibits investments in specific businesses as these are considered to be ‘haram’ (unlawful or undesirable) in Islam. These businesses include alcohol, drugs, pornography, gambling, tobacco, weapons, forecasting, environmentally harmful and highly volatile contracts etc (ACCA, 2011).

The above discussion might develop the notion that Islamic financial institutions are inflexible and rigid in their approach however it should be noted that it is only the misconception. These institutions are flexible within the boundaries set by Shariah and can conduct business in any industry except those forbidden in Shariah. However, even till date the numbers of these financial institutions is quite less as compared to conventional financial institutions and these are fragmented all over the world. There is a large untapped market for Islamic financial institutions which can play significant role in expanding their market share (IFSB, 2013). A few examples of Islamic financial institutions are Kuwait Finance House, Bahrain Islamic Bank, and Jordan Islamic Bank etc (WDIBF, 2009). Besides, a few international conventional banks like HSBC also deal into Islamic finance (Wagner, 2012).