Islamic banking operates under a unique set of principles derived from Islamic law (Sharia). These principles aim to promote ethical and socially responsible finance. Here's a breakdown of the key tenets:

1. Prohibition of Interest (Riba):

• This is the most fundamental principle. Riba refers to any predetermined or fixed return on a loan or investment. It's considered unjust and exploitative.


• Islamic banks avoid charging or paying interest in all their dealings.


• Instead of interest, they use profit-sharing, mark-up, leasing, and other Sharia-compliant techniques.

2. Profit and Loss Sharing (PLS):

• Musharaka: A joint venture where the bank and the customer contribute capital to a business project. Profits are shared according to an agreed-upon ratio, and losses are shared based on the capital contribution.


• Mudaraba: A partnership where the bank (Rab-ul-Maal) provides the capital, and the customer (Mudarib) manages the business. Profits are shared according to a pre-agreed ratio, but the bank bears the full financial loss (excluding the Mudarib's negligence or misconduct).

3. Prohibition of Speculation (Gharar):

• Gharar refers to excessive uncertainty, ambiguity, or speculation in contracts. It's avoided to ensure fairness and prevent exploitation.


• Examples of Gharar include:


• Contracts where the subject matter is unknown or uncertain.


• Insurance contracts with elements of gambling.


• Short selling (selling assets you don't own).


• Islamic banks focus on transparent and well-defined contracts.

4. Prohibition of Unethical Activities (Haram):

• Islamic banks cannot finance businesses involved in activities considered unethical or harmful according to Islamic principles. These include:


• Alcohol production and distribution


• Gambling


• Pork products


• Weapons manufacturing (in some interpretations, depending on the use)


• Pornography


• Activities that exploit or harm society

5. Asset-Based Financing:

• Islamic finance emphasizes a direct link between financial transactions and underlying real assets or economic activities.


• This means that financing is often tied to tangible goods or services, rather than purely monetary transactions.

6. Risk Sharing:

• Islamic finance encourages risk-sharing between parties involved in a transaction. This contrasts with conventional banking, where the lender typically transfers the risk to the borrower.


• This is evident in PLS contracts where both the bank and the customer share the potential for profit and loss.

7. Transparency and Disclosure:

• Islamic banks are required to be transparent in their dealings and provide full disclosure of all terms and conditions of their products and services.


• This helps customers make informed decisions and promotes ethical conduct.

8. Social Responsibility:

• Islamic banking emphasizes social responsibility and contributing to the welfare of the community. This includes:


• Providing financing for socially beneficial projects.


• Supporting charitable causes through Zakat (obligatory charity).


• Promoting sustainable and ethical business practices.

9. Sharia Supervisory Board:

• Islamic banks have a Sharia Supervisory Board (SSB) composed of qualified Islamic scholars.


• The SSB ensures that all products, services, and operations comply with Sharia principles.


• The SSB provides guidance and rulings on Islamic finance matters.

Common Islamic Banking Products:

• Murabaha (Cost-Plus Financing): The bank purchases an asset and sells it to the customer at a pre-agreed price that includes a profit margin. The customer pays in installments.


• Ijara (Leasing): The bank purchases an asset and leases it to the customer for a specific period, charging a rental fee. At the end of the lease, the customer may have the option to purchase the asset.


• Istisna'a (Manufacturing Financing): The bank finances the manufacture or construction of an asset based on a contract with the customer.


• Sukuk (Islamic Bonds): Certificates representing ownership in an asset or project. Sukuk pay returns based on the performance of the underlying asset, not on a fixed interest rate.


• Takaful (Islamic Insurance): A cooperative risk-sharing system based on mutual guarantee and contribution.

Key Differences Between Islamic and Conventional Banking:

Feature	Islamic Banking	Conventional Banking
Interest (Riba)	Prohibited	Permitted
Profit Source	Profit-sharing, mark-up, leasing, fees	Interest
Risk Sharing	Emphasized	Limited (primarily borrower bears the risk)
Speculation	Prohibited (Gharar)	Generally permitted
Ethical Concerns	Strict adherence to Sharia guidelines	Less emphasis on ethical considerations
Asset-Based	Emphasized	Can be asset-based or purely monetary

Challenges of Islamic Banking:

• Complexity: Sharia-compliant products can be more complex to structure and understand than conventional products.


• Standardization: Lack of global standardization in Sharia interpretations can create inconsistencies.


• Liquidity Management: Finding Sharia-compliant instruments for liquidity management can be challenging.


• Public Perception: Misconceptions about Islamic banking can hinder its adoption.


• Competitive Landscape: Islamic banks often face competition from larger, more established conventional banks.

In summary, Islamic banking provides an alternative financial system based on ethical principles, risk-sharing, and social responsibility. While it faces some challenges, it's a growing industry that offers unique solutions for individuals and businesses seeking Sharia-compliant financial services.