Hong Kong: Understanding Islamic Banking

Islamic banking is often thought to be financing the needs of the Muslim community only. In fact, it really refers to a system of banking activity that is consistent with Islamic principles and following the Islamic economics. With the rapid growth of the world-wide economy along with the expanding economy in the Islamic countries, Islamic banking is evolving to play a vital role in the world. The principles of Islamic banking differ substantially from those of conventional financing by traditional financial institutions. Islamic principles prohibit usury, the conducting any business involving Riba (interest), i.e. collection or payment of interest, under the Syariah law (Islamic law). Therefore Islamic banks were, during the Middle Ages, functioning essentially as savings institutions rather than commercial banks.

The principles of Islamic banking were derived from the Quran (the revealed book of Muslims) and the Prophet Muhammad (pbuh) and are governed by Shariah law (Islamic law). Islamic law besides prohibiting the payment and/or collection of interests, regardless of the purpose for which loans are made and the rates at which interests are charged, also prohibits activities dealing with liquor, pork, gambling, pornography and anything which Islamic law deems Haram (unlawful).

Islamic banking is instrumental to the development of an Islamic economic order which ensures social justice, such as forbidding all forms of economic activities which are morally or socially injurious, ensuring ownership of wealth legitimately acquired, allowing an individual to retain any surplus wealth and seeking to prevent the accumulation of wealth in a few hands to the detriment of society as a whole through its laws of inheritance.

The commercial purpose of Islamic banking is the same as conventional banking but it needs to operate within the principles stated above. Due to the rules of Shariah, Islamic finance products are often based on the principles of risk-sharing and profit-sharing. Common concepts used are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah) and leasing (ljarah). Such sharing principles can provide acceptable financial returns to investors by providing potential profit in proportion to the risk assumed. This type of structured products can satisfy the demands of investors in the contemporary environment within the guidelines of the Islamic Law. The most active financing provided are in the areas of trade, commodity finance, property and leasing.

Also, Islamic financing is only permissible to acceptable deals which exclude those involving alcohol, pork, gambling, etc. Therefore ethical investing is the only acceptable form of investment for Muslims.

We believe Islamic banking, with its unique principles will continue to grow and expand globally and the Islamic interest free mode of financing will continue to coexist with interest-based conventional financing.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.