Islamic banking stands as a unique financial system rooted in the principles of Islamic Law, or Shari’ah. Unlike conventional banking, which is fundamentally driven by interest-based transactions, Islamic banking operates on ethical, equitable, and risk-sharing foundations. As global interest in ethical finance grows, understanding the core concepts and evolution of Islamic banking is increasingly relevant.
Foundations of Islamic Banking
At its heart, Islamic banking is governed by two main principles:
Prohibition of Riba (Interest): Shari’ah strictly forbids the charging or payment of riba in any form. This is based on the belief that money should not be treated as a commodity that can earn profit on its own.
Profit and loss sharing: Instead of earning fixed returns, Islamic banks and their clients share profits and losses. This aligns the interests of all parties and promotes fairness.
Other guiding principles include the avoidance of uncertainty (gharar), prohibition of investing in haram (forbidden) industries (such as alcohol or gambling), and the requirement that all financial activities be backed by tangible assets.
How Islamic Banking works
Islamic banks offers a variety of Shari’ah-compliant financial products. Some of the most common structures include:
Mudarabah (Profit-sharing): One party provided capital, while the other manages the investment. Profits are shared according to a pre-agreed ratio, but losses are borne by the capital provider.
Musharakah (Joint Venture): Both parties contribute capital and share profits and losses proportionally.
Murabaha (Cost-Plus Financing): The bank buys an assets at the client’s request and sells it to them at a marked-up price, payable in installments. The markup is disclosed and agreed upon, avoiding hidden interest.
Ijara (Leasing): The bank buys an asset and leases it to the client, who pays rent instead of interest.
These models ensure that risk and reward are distributed equitably, and that financial transactions are tied to real economic activity.
History and modern growth
Islamic banking traces its roots to the early days of Islam in the 7th century. The Prophet Muhammad’s first wife, Khadija, was a successful businesswoman, and their commercial deals reflected many principles that underpin modern Islamic finance. During the Middle Ages, Islamic commercial practices influenced trade across the Mediterranean, Spain, and beyond.
The modern Islamic banking industry began to take shape in the 1960s and 1970s, with the establishment of dedicated Islamic banks in the Middle East. Today, Islamic banking is a global phenomenon, with assets exceeding $2 trillion and a presence in over 80 countries. In the Philippines, we have the Al-Amanah Islamic Investment Bank of the Philippines, the oldest Islamic bank in the country, with CARD Bank and Maybank Philippines offering Islamic banking services.
Despite its growth, Islamic banking faces challenges. Critics argue that some institutions merely repackage conventional products to appear Shari’ah-compliant, without truly adhering to Islamic principles. Ensuring rigorous Shari’ah oversight and transparency remains a key concern.
Islamic banking offers a compelling alternative to conventional finance, emphasizing ethical conduct, social justice, and shared prosperity. As the world seeks more responsible financial solutions, the principles of Islamic banking are likely to play an increasingly significant role in shaping the future of global finance.
