ISLAMIC transactions. Ø Introduction of an Islamic tax,

Topic: BusinessComparative Analysis
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Last updated: April 10, 2019

ISLAMIC BANKING:Islamic banking isdefined as banking system which is in consonance with the spirit, ethos andvalue system of Islam and governed by the principles laid down by Islamicsharia. While Islamic banking has a broader scope and meaning, it is generallyreferred to the transformation of conventional money lending system into assetbacked financing transactions conducted by the financial institutions. Islamicbanks involve themselves as intermediaries and investment oriented institutionsin bringing about well, being of the community, society and the economy in thelight of the Shari’ah.

The economic philosophy of Islam has no concept of riba(ursury) because according to Islam, riba is that curse in society, whichaccumulates money around hand full of people and results in creatingmonopolies, selfishness, greed, injustice and oppression. Islamic banking is agrowing sector with its diversity in different segments. It caters to muslimsas well as in countries where muslims live. Non-muslim communities that seekethical financial solutions have also been attracted to Islamic banking.

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 DEFINITION OF ISLAMICBANKING:The organisation ofIslamic conference defined Islamic banking as “a financial institution whose statutes,rules and procedures expressly state its commitment to the principles ofIslamic Shari’ah and to the banning of the receipts and payment of interest onany of its operation.” PRINCIPLES OF ISLAMICBANKING:Ø  Absenceof interest based (riba) transactions.Ø  Introductionof an Islamic tax, zakat.Ø  Sharingof profit and loss.Ø  Prohibitionof investing in unlawful businesses. PRODUCTS OF ISLAMICBANKING:·        Prohibition of riba·        Musharakah·        Mudarabah·        Murabah·        Takaful·        Ijarah·        Qard hasan·        Halal activities·        Sukuk·        Wadiah·        Salam·        Waqf  ·       PROHIBITION OF RIBA:The Arabic term riba is asynonym of interest which is used in conventional banking system. Islamconsiders money only as a medium of exchange and prohibits charging of anyinterest that is money earned out of lending money itself. Islam does notconsider money as an asset which can be ethically used to earn out of lendingmoney itself.

In Islamic banking, though riba is prohibited but equity basedreturns on investment are accepted. Lenders obtain ownership interest in theassets they finance or earn profit share or purely a fee-based remuneration.Islamic banks follow the accounting standards prescribed by accounting andauditing organisation for Islamic finance institutions. ·        MUSHARAKAH:It is profit and losssharing agreement or a participatory mode in Islamic banking. It is apartnership or a joint venture in which all the parties involved contribute tofinance a venture. Profits are shared by the parties based on a pre-agreedratios while losses are shared on the basis of equity participation by theparties as islam says one cannot lose what he did not contribute. Management ofthe venture can be either by all or by one partner. ·        MUDARABAH:It is a contractpartnership for profit/loss sharing in which one person brings the capital(known as the rabal-maal) and other the human skill needed to carry on theeconomic activity (known as mudarib).

The profits will be shared on pre-agreedratio, however losses will be borne only by the financier and not by mudarib.The loss shall also be passed on to the depositors. ·        MURABAH:It is a contract of salebetween the Islamic banks and the clients. Under this contract the banks buy anasset on behalf of the client and then sell it to them for a price plus anagreed profit for the banks. It is also known as mark-up or cost plus pricing.

Repayment by the client is made in the form of instalments. Murabah is mostcommonly financial operation used by the Islamic banks with which they earntheir profits and are able to prohibit payments of interest according toIslamic law. ·        TAKAFUL:It is commonly referredto as Islamic insurance. Takaful is based on the principle of cooperation andseparation between operations of shareholders and the funds. Therefore, theownership of takaful fund and operations are passed to the policyholders. Allpolicy holders agree to guarantee each other and contribute to a pool of funds(takaful fund) instead of paying premiums. Any claims made would be met out ofthe fund and surpluses will be distributed among policyholders. Takafuloperator would be paid a fee only for managing the fund and covering the costs.

 ·        IJARAH:It is a lease agreementbetween the Islamic bank and its client. The bank would buy an asset as per theclient and allow the client to use the asset for a specified lease period and alease fee. However the ownership of the asset shall remain with the bank. ·        QARD HASAN:Islamic banks lend loanson the basis of goodwill. No interest or profit is charged on these loans. Theborrower is required to pay only the amount she has borrowed.

These loans donot charge the borrower the time value for the money and are consistent withthe principle of prohibition of interest. ·        HALAL ACTIVITIES:Banks prohibit investingin any sinful (haram) activities. It prohibits and abstains from businessprojects related to gambling, pork products, weapons, defence, alcohol,pornography and any speculative activities according to sharia law. ·        SUKUK:It is an Islamicequivalent bond. The investor of sukuk shall get a share of an asset along withthe cash flows and the risk. As interest bearing bond is not permissible, theinvestor shall get a proportionate ownership in tangible asset of the project. ·        WADIAH:It is the acceptance ofthe sum of money for safe keeping which will be repaid. Bank is the keeper andtrustee of funds and liable for safe keeping of funds and returning them on thedemand of the customer.

Banks at its discretion shall reward the customers(hibah) as an appreciation for keeping the funds with the banks. ·        SALAM:It is equivalent to aforward sale contract in which the payment is made in advance and the goods aredelivered at a specified date in the future. This mode of financing is oftenused in the agricultural sector in which banks advance the money for inputswithout charging interest and in return shall get a part of produce which willbe sold after its delivery.    ·        WAQF:It refers to a voluntarydedication of one’s wealth and property for religious purposes. The waqfproperty can neither be sold nor inherited or donated to anyone but used forsharia complaiant projects.

  DIFFERENCE BETWEENCONVENTIONAL BANKING AND ISLAMIC BANKING: CONVENTIONAL BANKING ISLAMIC BANKING The functions and operating modes of conventional banks are based on man-made principles The functions and operating modes of Islamic banks are based on the principles of shariah i.e. the divine guidance. Money is treated as a commodity, besides medium of exchange and store of value. Therefore, it can be sold at a price higher than its face value and it can also be rented out. Money is not regarded as a commodity, though it is used as a medium of exchange and store of value. Therefore, it cannot be sold at a price higher than its face value or rented out.

Conventional banking practices are concerned with the elimination of risk. Reward should be a consequence of undertaking a risk. It’s all about risk taking and risk sharing.

The investor is assured of a predetermined rate of interest. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). Time value is the basis for charging interest on capital. Profit on trade of goods or charging on providing service is the basis for earning profit. Interest is charged even in case the organisation suffers losses by using bank’s funds. Therefore, it is not based on profit and loss sharing. Islamic bank operates on the basis of profit and loss sharing. In case, the businessman has suffered losses, the bank will share these losses based on the mode of finance used (mudaraba, musharaka).

While disbursing cash finance, no agreement for exchange (trade) of goods and services is made. The execution of agreements for the exchange of goods and services is a must, while disbursing funds under murabaha, salam and istina contracts (trade-base transactions). Conventional banks use money as a commodity which leads to inflation.

Islamic banking tends to create link with the real sectors of the economic system by using trade related activities. Since, the money is linked with the real assets therefore it contributes directly in the economic development. The status of a conventional bank, in relation to its clients, is that of creditors and debtors.

The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller, as well as, lessor and lessee. Involvement of economic activities involving speculation and gambling elements (gharar). Islamic banking transactions are gharar-free transactions. It ensures mutual benefit, covering and spreading risks of both counter parties to the contract by making each one’s obligations clear at the outset. It can charge additional money (penalty and compounded interest) in case of defaults.

The Islamic banks have no provision to charge any extra money from the defaulters. Instead an amount of payment is charge and these proceeds are given to charity. Conventional banks do not discourage the production of goods and services in any way which contradict the Islamic values. On the other hand, Islamic banks do not provide any assistance and strictly discourages the production of goods and services which are against the Islamic values(haram).    TOOLS USED BY BANKS:The tools used by banksare:·        Cash reserve ratio ·        Repo rate·        Reverse repo rate·        Statutory liquidity ratio·        Bank rate Ø  CASHRESERVE RATIO:Cash reserve ratio (CRR)is the amount of funds that the banks have to keep with RBI.

If  RBI decides to increase the percent of this,the available amount with the bank comes down. RBI is using this method(increase of CRR rate), to drain out the excessive money from the banks. Ø  REPORATE:Whenever the banks haveany shortage of funds they can borrow it from RBI. Repo rate is the rate atwhich our banks borrow money from RBI. A reduction in the repo rate will helpbanks to get money at a cheaper rate. When the repo rate increases borrowing fromRBI becomes more expensive.

 Ø  REVERSEREPO RATE:Reverse repo rate is therate at which reserve bank of India (RBI) borrows money from banks. Banks realways happy to lend money to RBI since their money are in safe hands, with agood interest. An increase in reverse repo rate can cause the banks to transfermore funds to RBI due to this attractive interest rates. It can cause the moneyto be drawn out of the banking system. Due to this fine tuning of RBI using itstools of CRR, bank rate, repo rate and reverse repo rate our banks adjust theirlending or investment rates for common man. Ø  STATUTORYLIQUIDITY RATIO:SLR is the amount acommercial bank needs to maintain in the form of cash or gold or governmentapproved securities (bonds) before providing credit to its customers. SLR rateis determined and maintained by the RBI in order to control the expansion ofbank credit. Ø  BANKRATE:Bank rate is also calledas the discount rate.

It is the rate of interest which a central bank chargeson the loans and advances provided to commercial banks.

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