INTRODUCTION TO

ISLAMIC BANKING
WITH
INTRODUCTION TO
ISLAMIC BANKING
WITH
 Presented by

Shariah Department, BankIslami Pakistan Limited

This booklet is authored by the Shariah

Department of BankIslami Pakistan Limited.
The purpose of preparing this booklet is to
increase awareness about Islamic Banking
amongst the public. Although this booklet
has been reviewed in detail, kindly inform
us on following email address regarding any
improvement / rectification so that the
correction can be made in the next edition:

JazakAllah

[email protected]

First Edition 2022

 Foreword

Our religion, Islam, is a comprehensive and complete religion which means that it
provides guidelines pertaining to every aspect of life. These guidelines, in addition to
the acts of worship (Ibadaat), also encompass other areas of life which include beliefs
(Aqai’d), financial dealings (Muamlaat), social relationships (Muaashrat) and moral
characters (Ikhlaqiyat). It is an important requirement of Islam to follow all these
guidelines in entirety to become an ideal Muslim. Islam also gives a comprehensive

aspects of life. In current times, Islamic banking, as a Shariah compliant alternative of

conventional banking, ensures that banking services are being offered in compliance
with the dictates of Islam.

BankIslami Pakistan Limited is one of the leading financial institutions offering

Islamic banking services. As a mission-driven bank, BankIslami aims at spreading
awareness of Islamic banking concepts amongst the public. This booklet titled
“Introduction to Islamic Banking, with BankIslami” is a part of these efforts. The
booklet addresses topics such as general services offered by a bank, need of Islamic
banking, difference between Islamic and conventional banking, products offered by
Islamic banks and answers to frequently asked questions.

I hope this effort will be beneficial in increasing the awareness of basic concepts of
Islamic banking. The readers are requested to share their valuable suggestions and
recommendations as they will play an important part in making this endeavor fruitful
and assist us in making improvements in the next edition.

May Allah Subhana wa Ta’ala accept this effort and make it beneficial and helpful in
saving humanity from Riba.

Mufti Irshad Ahmad Aijaz

Chairman, Shariah Board
BankIslami Pakistan Limited
 Table of Contents

Islam, a complete code of life 6

Importance of financial dealings 6

Bank 7

Need and importance of a bank 7

1. Security of funds 7

2. Investment 7

3. Facility to fulfill financial needs of customers 7

4. Providing funds required for running business 8

Need for Islamic banking: 8

Interest - The reason for prohibition of conventional banking 9

Prohibition of Interest (Riba) in the light of Holy Quran 9

Prohibition of Interest (Riba) in the light of Ahadith 10

Islamic bank 10

Characteristics of an Islamic bank 10

Main Differences in Islamic and conventional banking 11

Islamic Banking Model 11

1. Deposit Side 12

2. Asset Side 12

Basis of Deposits in Islamic banking 12

Qard 12

Mudarabah 13
 Rules of Mudarabah

Mudarabah with depositors

Procedure of Mudarabah in Islamic banks

Modes of Financing in Islamic banking

Musharakah (Partnership)

Rules of Shirkat-ul-Milk

Rules of Shirkat-ul-Aqd

Diminishing Musharakah

Application of Diminishing Musharakah

Running Musharakah

Application of Running Musharakah

Rent/Leasing

Ijarah

Rules of Ijarah

Application of Ijarah

Trade

1. Murabahah

Musawamah

Rules of Murabahah and Musawamah

Application of Murabahah and Musawamah

2. Tijarah

Rules of Tijarah

Application of Tijarah
 3. Salam 18

Rules of Salam 18

Application of Salam 19

4. Istisna 19

Rules of Istisna 19

Application of Istisna 19

Frequently Asked Questions regarding Islamic Banking 20

Conclusion 23

Our Responsibility 23
Islam: A complete code of life
The guidelines of Islam are not only limited to acts of worship (Ibadaat) but they also
cover other aspects of life which include beliefs (Aqai’d), financial dealings
(Muamlaat), social relationships (Muaashrat) and moral character (Ikhlaqiyat).
Accordingly, Islam requires Muslims to adopt its teachings in a holistic manner
encompassing both their individual
and communal spheres of life. In this Islamic banking was introduced with the
booklet, we will discuss guidelines purpose of offering banking services
pertaining to banking and financial without the element of interest and other
dealings as Islam stresses upon the prohibitions in Islam. In Islamic banking,
correctness and sanctity of financial it is ensured that the deposits are
dealings. Therefore, as Muslims, it is received and financing is offered in a
imperative for us to have a basic Shariah compliant manner thereby
understanding about this aspect of making it a Shariah compliant alternative
our faith. of conventional banking.

Importance of financial dealings

As Muslims, it is our responsibility that, in addition to practicing other aspects of our

faith, we follow the guidelines of Islam in our financial dealings as well. Negligence in
financial dealings also negatively impacts the acceptance of other acts of worship
(Ibadaat). As per a Hadith, any charity (sadqa) given from impermissible (haram)
earnings is not accepted (Sunun Nasai, Hadith no. 2526). According to another Hadith,
supplication (dua) of that person is not accepted who consumes from impermissible (haram)
earnings (Sahih Muslim, Hadith no. 2346). It is evident from these narrations that earning
in a permissible (halal) manner plays a crucial role in the acceptance of supplications.

The real success of a Muslim is success in the hereafter (Akhirat). In fact, it is the fear of
accountability in the hereafter that distinguishes a Muslim from other human beings.
According to a Hadith, a person would not be allowed to move from his/her position
on the Day of Judgment until he/she has been asked five questions – two of which
pertain to earnings and expenditures i.e. what was the source of earnings and where
was it spent? (Sunan Darami, Hadith no. 556). Therefore, only a cautious approach in
earnings and expenditures can save a Muslim from punishment in the hereafter.

For this purpose, we need to ask ourselves what are the requirements that Shariah
expects us to fulfill while entering into financial dealings? If we are not aware of them
then let us start! This booklet will not only teach us some of the basic rulings of Islam
regarding financial dealings but also address questions like how Islamic banks are
fulfilling the financial needs of customers within the ambit of Shariah? What are the
products offered by Islamic banks?

Before moving on to the detailed guidelines of Islam for financial dealings, let us first
review the activities of a conventional bank.

06
Bank

We deal with a bank to perform different tasks such as utility bills payment, deposit
and encashment of cheques, etc. but fundamentally, a bank is an institution that accepts
deposits in the form of different accounts and fulfills financial needs by extending
financing facilities.

Need and importance of a bank

We can understand the need and importance of banks by noticing their impact on
commercial activities. For instance, it can be observed that business activity is generally
higher on the days the banks are open whereas on the days they are closed, a decrease
in the volume of business activity is quite evident. This shows that banking is a vital cog
in the functioning of modern economy. Its importance and need is further emphasized
through the following points:

1. Security of funds

We usually do not consider keeping large amount of cash at home as it can be stolen
but if it is deposited in a bank, we consider it to be secure. Banks provide the facility of
Current Accounts which make sure that the cash remains protected while giving an
option to the account holders to withdraw the cash whenever required.

2. Investment

Most of us spend our earnings with prudence so that we can save some amount in case
any urgent requirement arises in future. If such savings are kept at home, we can
neither earn any profit on it nor can we avoid the erosion of their value due to inflation.
For this purpose, banks offer Saving Accounts and Term Deposits as effective tools of
investment to earn a suitable profit.

3. Facility to fulfill financial needs of customers

Most of us require funds to purchase car, house, home appliances, etc. Banks offer
different financing facilities to fulfill these needs.

07
4. Providing funds required for running business

To run a business, sometimes short term funding is required to purchase raw material
(for manufacturing purposes), payment of salaries, utility bills, etc. In some cases,
financing is required for a longer term e.g. to construct a factory or to acquire machinery.
Banks cater to all these business needs.

In addition to the above-mentioned services, banks also provide a number of other

services.

The different array of services offered by

The services offered by a
the bank play a vital role in today’s
society. Therefore, even if an institution bank have become indispensable
offering these services is not called a today in order to cater to the needs of
‘bank’, there will still be a need for the the contemporary economic world
provision of these services that have and complex financial needs. Islamic
become a necessity in the modern day banking was introduced to offer
and age. From an Islamic perspective, these services in a Shariah compliant
of course, these services are required to manner.
be provided in a Shariah compliant
manner.

Need for Islamic banking

A fundamental question now arises about the reason of existence of Islamic banking i.e.
when a banking system already exists then why suggest a new mechanism? We have
addressed this earlier that, while it is a reality that banking has become a fundamental need
for the society, its business structure is based on the concept of borrowing and lending.
Conventional banks fulfill the financial needs of customers by earning and paying
additional amounts on loans (qard) which is tantamount to interest. On the other hand,
when we study Islamic teachings we realize that earning any additional amount on loan
(qard) has been clearly prohibited by Allah Subhana wa Ta’ala in the Holy Quran. This
implies that it is not permissible from the Shariah perspective to fulfill the banking needs by
borrowing and lending on interest (riba). This leads to the need for Islamic banking so that
the banking services can be offered on the basis of Shariah principles.

08
Interest - The reason for prohibition of conventional banking

Financial dealings should be free from the element of interest, also referred to as ‘Riba’
in Arabic language with a literal meaning of ‘addition’ or ‘increase’. When we search
for the meaning of interest (riba) in Shariah, we come across a quote by Hazrat Ali
(RadiAllahu anhu) which is as follows:_____________________ (Al Matalib Al Aalia,
Hadith no. 1440) and it is translated as “Any such loan that brings a benefit on it (i.e.
any additional amount received on it) is interest (riba)”.

It is evident from this quote that any addition on all types of loan will be termed as
interest (riba) i.e. whether the loan has been taken for commercial/business purposes
or for personal financial needs and whether the addition/gain has been received in
cash or in the form of any other benefit. Even if this addition/gain is termed differently,
e.g. mark-up or profit, it is important to remember that if the transaction is based on a
loan (qard), any agreed addition/gain on the loan would be interest (riba).

Clearing a Misconception

Many people think that the amounts deposited with a conventional bank are not
on a loan (qard) basis but on a trust (amanat) basis; therefore, in the absence of
(riba)
understood that this is a loan arrangement from Shariah perspective as the bank
guarantees the deposited funds and uses the funds in its business activities both
of which are characteristics of a loan (qard). From Shariah perspective, funds
received on the basis of trust (amanat) are not allowed to be used and are required
to be returned in the same condition as they were received. Additionally, trust
funds (amanat) cannot be guaranteed and are not bound to be compensated if
lost without any negligence.

Prohibition of interest (riba) in the light of Holy Quran

Interest (riba) has been mentioned on four occasions by Allah Subhana wa Ta’ala in
the Holy Quran:
1 Verse no. 275 – 281, Surah Al Baqarah
2 Verse no. 130, Surah Aal e Imran
3 Verse no. 161, Surah An Nisa
4 Verse no. 39, Surah Ar Roum

A summary of the teaching of these verses is as follows:

Apparently interest (riba) increases wealth but it does not increase in the view
of Allah Subhana wa Ta’ala. This connotes that there is no barakah in interest
earning.
Interest (riba) and profit earned through trading appear to be the same but
(riba)

in Shariah status but it is the process that defines it.

09
 Allah Subhana wa Ta’ala increases charity (sadaqaat) and decreases interest
(riba).
There is a declaration of war by Allah Subhana wa Ta’ala and Prophet
Muhammad ‫ ﷺ‬against those who do not give up on interest (riba).

Prohibition of interest (riba) in the light of Ahadith

Interest (riba) has been disallowed and admonished severely in Ahadith. Some of
these Ahadith are as follows:

Prophet Muhammad ‫ ﷺ‬has cursed upon the receiver of interest (riba), payer of
interest (riba), the witnesses and the recorder of the interest (riba) based
transaction and mentioned that all are equal in the sin. (Hadith no. 1598,
Muslim)
The evil of interest (riba) has been described in such a manner that interest
(riba) has seventy degrees and the least degree of it is equivalent to a person

Maaja)

One of the wisdoms behind the impermissibility of interest (riba) is that it prevents
actual economic activities. If one were allowed the option to earn a profit simply by
lending, why would that person want to bear the risk of investing in actual real
economic activities? This, in turn, affects the economic welfare of the society that can
be ensured only through real economic activities. (Imam Ghazali Rahmatullah Alaih)

It is clear that the element of interest (riba) is present in conventional banking and the
need of Islamic banking is evident. In the following segment, we will learn how
Islamic banks function.

Islamic bank

An Islamic bank is an institution which provides banking services i.e. accepting

deposits, providing financing facilities, etc. in compliance with Shariah principles.

Characteristics of an Islamic bank

Following are the characteristics of an Islamic bank:

Ensures all transactions are Shariah compliant i.e. the transactions are free
from the elements of interest (riba) as well as other prohibitions in Shariah
such as Gharar (excessive uncertainty), Qimar (Gambling), etc.
Ensures to receive deposits and extend financing facilities in compliance with
Shariah principles.
Provides facilities for Shariah compliant businesses only.

10
Main Differences in Islamic and conventional banking

Following are some of the main differences in Islamic and conventional banking:

Islamic bank Conventional bank

Basis All Islamic banking activities comply Major activities of conventional bank are
with Shariah principles. Shariah non-compliant.

Deposits Islamic banks accept saving deposits Conventional banks accept saving
Structure on the basis of Mudarabah (profit and deposits on loan (qard) basis which
loss sharing basis). results in interest (riba).

Customer Islamic banks do not deal with Conventional banks can deal with such
customers whose core business activity customers whose core business activity is
is completely Shariah non-compliant. completely Shariah non-compliant.

Modes of Islamic banks provide financing Conventional banks extend financing

Financing facilities on the basis of Shariah facilities through interest (riba) based
compliant contracts such as Shirkat loans which is prohibited in Shariah.
(Partnership), Sale/Purchase, Ijarah
(Rent), etc.
Shariah All financial dealings of an Islamic In the absence of a Shariah Governance
Governance bank are governed through a System, there is no mechanism of a
System comprehensive ‘Shariah Governance Shariah based supervision of the financial
System’. dealings of a conventional bank.

Islamic Banking Model

Banking activities can be categorized as:

1. Deposit side
2. Financing (Asset) side

Conventional Banking

Deposit Side Asset Side

Loan (qard) Loan (qard)

Let us now understand how an Islamic bank ensures that these two activities are in
compliance with Shariah principles!

11
 Islamic Banking

Deposit Side Asset Side

Non-interest
Mudarabah Partnership Lease/Rent Trade
based loan

In Islam, a loan (qard) is a non-remunerative contract i.e. it can only be

interest-free which is why it cannot form the basis of a business transaction.
Therefore, to earn a profit, it is important to use contracts in which remuneration
is permissible in Shariah such as Partnership (Shirkat), Lease (Rent), Trade, etc.
The use of such contracts is what primarily distinguishes Islamic banking from
conventional banking.

1. Deposit side

Islamic banks accept Current Account deposits on the basis of non-interest based loan
(qard). Whereas the Saving and Term deposits are accepted on the basis of Mudarabah
which are invested in Shariah compliant businesses/activities on profit and loss
sharing basis.

2. Asset side

Islamic banks provide financing facilities to customers through different Shariah

compliant modes/products that include Murabahah, Salam, Istisna, Diminishing
Musharakah, etc. Details of these Shariah compliant modes/products will be discussed
ahead.

Basis of Deposits in Islamic banking

Qard (Loan)

This is a transaction in which a thing of value (often money) is given by a lender to

borrower for their use. The loan is to be repaid by the borrower on demand of the
lender.

It is permissible in Shariah to give a loan. However, it is not allowed to receive any

additional gain/benefit on it as it is tantamount to interest (riba) which is impermissible
(haram).

12
In Islamic banks, Current accounts are generally opened on loan (qard) basis as the
purpose of such accounts is not to earn any profit but to keep the funds secure and
guaranteed. As customers do not assume any risk on such funds, they are not entitled
to earn any profit on it. Moreover, in line with the Shariah requirements pertaining to
loan (qard), the bank ensures that customers receive deposited amounts on demand.

Mudarabah

Mudarabah is a partnership in which one partner invests funds while the other partner
manages the work. The profit earned is distributed between them as per a pre-agreed
profit sharing ratio. The Investing Partner and Managing/Working Partner are referred
to as “Rabb-ul-Maal” and “Mudarib” respectively.

In Saving and Term deposits, an Islamic bank works in the capacity of Working Partner
(Mudarib) whereas the depositors are Investing Partners (Rabb-ul-Maal). After
receiving the deposits on Mudarabah basis, Islamic banks invest them across various
Shariah compliant avenues e.g. rental arrangements, commercial partnerships,
trading, investments, etc. to earn profit.

Rules of Mudarabah

Following are some of the important rules to be followed in a Mudarabah

arrangement:

The partners must agree upon the profit sharing ratio at the time of entering
into Mudarabah.
The Investing Partner (Rabb-ul-Maal) and Working Partner (Mudarib) cannot
pre-agree a fixed profit amount.
Profit amount cannot be linked to the investment amount e.g., it is
impermissible to agree that profit will be received as 10% of Rs. 100,000 (capital
invested).
In case of Loss, the Investing Partner (Rabb-ul-Maal) will bear it completely
while the Working Partner (Mudarib) will not earn any profit for rendered
services. However, if the loss incurred is due to negligence of Working Partner
(Mudarib), it will have to be borne by Working Partner (Mudarib).

Mudarabah with Bank’s depositors

Normally in a Mudarabah, there is one Working Partner (Mudarib) and one Investing
Partner (Rabb-ul-Maal). In Mudarabah with an Islamic bank, however, all the
depositors (of Saving and Term deposits) are collectively the Investing Partner
(Rabb-ul-Maal) and the Islamic bank is the Working Partner (Mudarib). Record
keeping of all depositors' investments (considering that they are allowed to invest
and withdraw funds frequently) and subsequent profit and loss distribution
separately with each depositor is a strenous activity. Hence, to make this activity
easier and practical to execute, a mechanism has been designed under the
guidance of Shariah Scholars which is discussed ahead.

13
Procedure of Mudarabah in Islamic banks

The duration of Mudarabah is set as one month with renewal at the end of every
month. At least three working days prior to the start of every month, the profit sharing
ratio between the bank and the depositors as well as the weightages between the
depositors in the Deposit Pool are decided and announced. These profit sharing ratio
and weightages are published on the bank’s website and notice board of the bank’s
branches.

The term ‘Pool’ in Islamic banks normally refers to a notional pool of funds formed
through deposits. ‘Weightages’ are used to differentiate between the depositors based
on the difference in their deposit amounts and tenures. For example, a depositor
investing funds, on Mudarabah basis, with the bank for 5 years can be assigned a
higher weightage (entitling him/her to earn higher profit) as compared to a depositor
who is investing funds for 3 years.

Upon the end of the month, the profit earned from banking operations is divided
between the bank and Pool as per the pre-agreed profit sharing ratio. After this
exercise, the profit earned by the Pool is distributed by the bank amongst the
depositors as per the weightages on Monthly Average Balance basis.

An expected rate of profit can be quoted on the deposits received under

Mudarabah i.e. remunerative deposits, but this profit rate cannot be guaranteed.
The profit is distributed on the basis of pre-agreed profit sharing ratio and
weightages. At the end of the Mudarabah term, if the bank earns a profit, each
partner is entitled to a share in it as per the pre-agreed profit sharing ratio and
weightages. This actual profit earned may be less or more than the expected profit
rate quoted beforehand.

Modes of Financing in Islamic banking

Partnership (Shirkat)
In Islamic jurisprudence (fiqh), the term ‘Shirkat’ is used for Musharakah, which means
to enter into a partnership. There are two types of Shirkat:

1. Shirkat-ul-Milk (Co-ownership of asset):

This means co-ownership of two or more persons in an asset without a

father, two persons jointly purchasing a property for own use, etc.
2. Shirkat-ul-Aqd (Partnership in business):
This means partnership of two or more persons in a commercial enterprise. In
such a partnership, the profit earned is shared as per a pre-agreed profit
sharing ratio, whereas, any loss incurred is shared as per investment ratio.

14
Rules of Shirkat-ul-Milk

Following are some of the important rules of Shirkat-ul-Milk:

One of the partners can rent their share to a third party with the consent of the
other partner.
The co-owners/partners share the risk and reward of the owned asset as per
their ownership ratio.

Rules of Shirkat-ul-Aqd

Following are some of the important rules of Shirkat-ul-Aqd:

Profit sharing ratio needs to be agreed at the time of entering into the
partnership.
Profit amount for any partner cannot be pre-agreed. It also cannot be linked to
the investment amount e.g., it is impermissible to agree that profit will be
received as 10% of Rs. 100,000 (capital invested).
Loss will always be borne by the partners as per their investment ratio.
However, if the loss is incurred due to the negligence of a partner, then the loss will
be borne by that partner.
In principle, all partners have a right of working for the business. However, the
partners can agree that a partner will not work/be involved in the management.
In such case, the profit sharing ratio of that partner cannot be higher than
his/her capital investment ratio.

Currently, Islamic banks offer the following two financing products based on
Musharakah:

1. Diminishing Musharakah (based on Shirkat-Milk)

2. Running Musharakah (based on Shirkat-ul-Aqd)

Diminishing Musharakah
Diminishing Musharakah is generally offered on the basis of Shirkat-ul-Milk. Following
are the three legs of a Diminishing Musharakah transaction:

1. Shirkat-ul-Milk (Partnership):
In the first leg, the bank and customer jointly purchase an asset and become
co-owners that establishes their joint ownership in that asset.

2. Ijarah (Lease):
The bank rents out its share in the asset for use to the customer against agreed
rentals.

3. Sale of ownership share:

The bank, from time to time, sells its ownership share in the asset to the
customer. Over the period, the customer’s share in the asset increases and
accordingly the bank’s share decreases. Upon purchase of entire bank’s share,
the customer becomes the sole owner of the asset.

15
Application of Diminishing Musharakah

Diminishing Musharakah is widely used as a mode for long term financing to fulfill
different needs of the customers such as house financing, auto financing, project
financing, acquisition of capital assets, etc.

Running Musharakah

Another way of offering financing facility on Musharakah basis is Running

Musharakah. This is a Shariah compliant alternative of the conventional Running
Finance facility. Running Musharakah is offered on the basis of Shirkat-ul-Aqd in
which the bank becomes a partner in the business operations of the customer on profit
and loss sharing basis.

Following are some key features of Running Musharakah:

The bank becomes a partner in the core business operations of the customer.
The funds provided by the bank to the customer are an investment of bank in
the business of the customer.
The funds paid back by the customer to the bank reflect a decrease of bank’s
investment share in the business of customer along with withdrawal of
provisional profit.
The profit sharing ratio is normally set according to the respective ratios of
investment.
Upon availability of the audited financial accounts of the customer, the profit
and loss calculations of the Running Musharakah are finalized and provisional
profits are adjusted accordingly.
In case of loss in Musharakah, loss is shared as per the investment ratio.

Application of Running Musharakah

Running Musharakah is offered by Islamic banks as a way of providing running

finance facility to the customers in a Shariah compliant manner.

Rental/Lease Arrangement

Ijarah

Ijarah means rental/lease arrangement i.e. to give something for use against rentals. In
Ijarah, the person renting out (lessor) remains the owner of the asset, whereas, the
other person (lessee) uses the asset. The ownership related risks and expenses remain
responsibility of the lessor whereas the usage related expenses are borne by the lessee.

16
Rules of Ijarah

Following are some of the important rules of Ijarah:

Ijarah contract can only be entered into for assets that remain useable. Assets
that are consumed upon their usage e.g. petrol, gas, etc. cannot be made subject

The description and specification of Ijarah asset must be clearly known at the
time of entering into Ijarah.
The tenure and rental amounts of Ijarah must be mutually agreed by the
contracting parties.
The ownership related risks and expenses shall remain responsibility of the
lessor.
The usage related expenses shall be borne by the lessee.

Application of Ijarah

Ijarah is a commonly used mode for long-term financing. Auto financing, plant and
machinery acquisition financing, etc. are commonly offered on Ijarah basis by Islamic
banks.

Trade

Islamic banks provide financing on sale/purchase basis mainly through the following
four methods:

1. Murabahah

Murabahah is a sale transaction in which the seller discloses the cost of goods to the
buyer.

Musawamah

Musawamah is a sale transaction in which the seller only discloses the total price of
goods i.e. the cost and profit break-up is not disclosed to the buyer.

Rules of Murabahah and Musawamah

Following are some of the important rules of Murabahah/Musawamah:

The goods must exist and be under the ownership and possession (whether
physical or constructive) of the seller at the time of entering into a sale transaction.
The payment terms of the sold goods must be mutually agreed and can be
on advance, spot or credit/installment basis.

17
Application of Murabahah and Musawamah
Islamic banks offer financing based on Murabahah in cases where the customers
require funds to purchase goods, that can be raw material or finished goods.

2. Tijarah
In certain cases, customers have finished goods available with them for onward sale in
the market on a credit basis. If such customers require financing, bank purchases the
finished goods from them at a discount on cash basis. The bank then appoints the
customer as its agent to sell the goods in the market at a profit. This way of providing
financing facility to customers is generally termed as ‘Tijarah financing’.

Rules of Tijarah

Following are some of the important rules of a Tijarah transaction:

The goods shall be in existence, identified and under the ownership of the seller
at the time of sale.
The goods shall be under physical or constructive possession of the seller at the
time of sale.
The price of the sold goods must be mutually agreed.

Application of Tijarah
Tijarah Financing is offered in cases where the customer has finished goods available
for onwards sale and requires liquidity to meet the running expenses of its business.

3. Salam
Salam is a sale transaction in which the complete sale price is paid in advance by the
buyer whereas the commodity is to be provided by the seller on agreed future date.
Such sale transactions are permissible in Shariah under certain conditions. Even
though the general rules of a sale transaction (i.e. the existence of commodity and the
commodity being in ownership/possession of the seller) are not met at the time of
entering into a Salam transaction, it has been allowed as an exception to these rules in
the light of Ahadith.

Rules of Salam
Following are some of the important rules of a Salam transaction:
Salam is only allowed for commodities which are homogeneous and fungible
in nature i.e. every unit of the commodity should be identical and substitutable
in nature e.g. sugar, rice, wheat, etc.
The commodities shall be completely specified i.e. type, quantity, etc. and the
price and other important terms shall be agreed at the time of entering into
Salam in such a manner that no ambiguity remains.
It is important to agree upon the delivery date and the delivery place at the time
of entering into Salam transaction.
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Application of Salam

Financing is offered under Salam in cases where the customer can supply certain
commodity (which fulfills Salam conditions) to the bank on a future date and requires
liquidity to meet the running expenses of its business.

Upon receipt of possession of the commodity, the bank generally appoints the
customer as its agent to sell the commodity in the market at a profit.

4. Istisna

manufacturing. Generally, the buyer gives an order to the seller and the seller
manufactures the asset keeping in view the buyer’s requirements. The payment terms
can be mutually agreed to be advance, cash, credit or on instalment basis. The asset is
manufactured and delivered to the buyer at a later date. In Istisna as well, even though
the general rules of a sale transaction (i.e. the existence of asset and the asset being in
ownership/possession of the seller) are not met at the time of entering into Istisna
contract, it is permissible in Shariah, subject to certain conditions. Therefore, it has been
allowed as another exception to these rules in the light of Ahadith.

Rules of Istisna

Following are some of the important rules of an Istisna transaction:

The asset to be manufactured shall be specified at the time of entering into
Istisna contract in an unambiguous manner.
If the manufactured asset is not as per agreed specifications, the buyer has the
right to return the asset.
Price and payment terms shall be mutually agreed upon.
The raw material required for manufacturing shall not be provided by the
buyer i.e. the seller shall use its own raw material.

Application of Istisna

Financing is offered under Istisna in cases where the customer can manufacture/deliver
certain assets (which fulfill Istisna conditions) to the bank on a future date and
requires liquidity to meet the running expenses of its business.

Upon receipt of possession of the manufactured asset, the bank generally appoints the
customer as its agent to sell the asset in the market at a profit.

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Frequently Asked Questions regarding Islamic Banking

Is there any concept of banking in Islam?

Indeed, yes. If an institution receives funds under a Shariah compliant arrangement

and invests those funds in a Shariah compliant manner in commercial transactions to
earn profit, and if such an institution is termed as a ‘bank’ then the concept of such an
institution definitely exists in Islam. However, if a bank deals in interest based
transactions, there is obviously no such concept in Islam. In the early years of Islam, we
have the example of a famous companion, Hazrat Zubair bin Awam (RadiAllahu anhu)
with whom people wished to deposit their money on a trust basis (amanah) due to his
trustworthiness. He used to refuse to accept funds on trust (amanah) basis; however,
he agreed to accept funds as loan (qard) and would then invest those funds in trading
activities. This practice of Hazrat Zubair (RadiAllahu anhu) of receiving funds and then
investing onwards in trade activities is quite similar to the practice of the banks today
(Page no. 68, ‘A Historic Judgment on Riba’ by Mufti Muhammad Taqi Usmani).

Does an Islamic bank deal in interest (riba) with State Bank of Pakistan?

No. The State Bank of Pakistan has two different relationships with Islamic banks.
Firstly, the State Bank of Pakistan, in the capacity of a regulator, issues instructions over
time that are generally of an administrative nature e.g. providing instructions on
improving customer service, etc. Secondly, at times the Islamic banks and State Bank of
Pakistan enter into financial transactions. In such cases, it is always ensured that the
financial transactions comply with Shariah principles.

Islamic banking and conventional banking apparently look the same. Is

Islamic banking not the same as conventional banking except for different
terminologies?

Not at all. It is not necessary that if the end result of two different processes is the same
then the same Shariah ruling will be applicable on both. We come across different
examples of this in daily life. For example, one animal can be slaughtered with the
name of Allah Subhana wa Ta’ala and the other without His name. After being
slaughtered, meat of both animals will appear to be the same. But the meat of one
animal will be considered permissible (halal) and the other as impermissible (haram)
considering the difference in the process of slaughtering between the two.

Similarly, it will be incorrect to say that since an Islamic bank earns the same as a
conventional bank, therefore, there is no difference between the two. For instance, if a
person is selling juice and another person is selling alcohol and the profit amount
earned by both is the same, then just because of the same profit amount, the earnings
of the juice seller cannot be considered impermissible. Also, consider a situation where
a person is hungry. In order to satisfy his/her hunger, that person can either earn
through lawful means or commit a robbery. In both cases, the hunger will be satisfied
i.e. the end result will be same but one process will be considered permissible and the
other impermissible. Therefore, a Shariah ruling cannot be given just on the basis of the
end result; in fact, the whole process, along with the terms and conditions agreed
between the parties, will have to be looked into before arriving on an opinion.

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Conventional banks receive penalty from customers in case of delay in
payments. Islamic banks also receive an additional amount as charity from
customers in case of delays. Is this additional amount also not interest
(riba)?

The additional amount received by the conventional banks as penalty from the
customers on delayed payments is interest (riba) as the underlying contract in
conventional banking is of loan (qard). Such penalty also becomes part of the income of
the conventional banks.

Whereas, the additional amount received by the Islamic banks is a Charity amount
which customers, at the time of entering into the financing transaction, promise to give
in charity, upon demand of the bank, in case there is a delay in payments by the
customers. Such Charity amount does not form part of income of the Islamic bank and
is distributed to charitable institutions, on behalf of the customers. This arrangement is
used to discourage customers from delaying their payments and is permissible in
Shariah. The Islamic banks give complete disclosure about the Charity amount
received and the amount distributed during the year in their annual audited accounts.

Is it right for Islamic banks to use an interest rate benchmark e.g. KIBOR in
their financing transactions?

The question itself mentions that KIBOR is a benchmark which simply means a
standard to gauge something or the market rate e.g. in the Karachi gold market, a
standard market rate of gold is used as the basis for the trading of gold in the local
market. Similarly, KIBOR is simply a market rate announced by State Bank of Pakistan
on a daily basis for the local financial market which is used by the banks as the
benchmark rate for offering financing facilities. Although KIBOR is the average rate at
which the banks want to lend money to each other, this rate is not interest (riba) in
itself. Instead, its classification as interest (riba) will depend upon whether or not the
underlying transaction in which it is used is a loan (qard) based transaction. This
implies that regardless of how the benchmark rate is derived, if the benchmark rate is
being used to earn interest (riba) in a loan (qard) transaction, the transaction is
impermissible – not because of the use of that rate but because of it generating interest
(riba). However, if the same benchmark rate is used to determine the profit amount in
a sale transaction, such profit amount is permissible because the price is being received
against sale of some goods.

Let us understand this with an example. If someone were selling impermissible

(haram) meat at a profit rate of 10%, the income earned would obviously be impermissible.
However, if another seller is selling permissible (halal) meat at the same profit
rate, his/her income cannot be called impermissible just because of using the profit rate
of an impermissible transaction as a benchmark. Similarly, Islamic banks earn their
profit mainly through sale, rent or partnership based transactions, while abiding by all
Shariah requirements. Therefore, just by using KIBOR as a basis for profit rate in a sale
transaction or rental rate in a lease transaction does not make that sale profit and lease
rental impermissible.

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Islamic banks are working in accordance with the principles of Shariah. How
can one be sure of it?

To answer this question, one will have to understand the Shariah Governance System
that is in place for the Islamic banks. The Shariah Governance System comprises of the
following:

Bank's
Shariah
Board

Internal Shariah
Shariah Committee
Audit of SBP
Shariah
Governance
System
External Shariah
Shariah Compliance
Audit Department

Shariah
Inspection
of SBP

1. Bank’s Shariah Board:

It is mandatory for every Islamic bank to appoint a Shariah Board comprising of
authentic Shariah Scholars. The Shariah Board is responsible to review and approve
different products and services offered by the Islamic bank.

2. Shariah Compliance department:

It is also mandatory for every Islamic bank to establish a Shariah Compliance
department. This department acts as a secretariat of Shariah Board and is responsible
to review the transactions, agreements, policies and procedures of the bank from a
Shariah perspective. Shariah Compliance department also conducts Shariah
Compliance review of the activities of other departments as well as the branches of the
bank to ensure that the guidelines of Shariah Board are being properly implemented.

3. Internal Shariah Audit:

Along with Internal Audit, conducting Internal Shariah Audit is also mandatory for
Islamic banks. Internal Shariah Audit Unit conducts audit of the activities of the bank
from Shariah perspective.

4. External Shariah Audit:

Arranging External Shariah Audit of its activities is also mandatory for an Islamic bank
in which a reputable audit firm conducts audit of the bank’s activities from Shariah
perspective.

issues different guidelines and policies for the Islamic banking industry.

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6. Islamic Banking Department of State Bank of Pakistan:
The Department was established in the State Bank of Pakistan in 2003 to facilitate
and catalyze the development of Islamic Banking in Pakistan. The department
issues guidelines and instructions related to Shariah related matters of Islamic
banks. The department also reviews the different products and services offered
by Islamic banks and issues Islamic Banking Industry bulletin which provides an
update on the overall progress of the Islamic Banking Industry.

7. Inspection Team of State Bank of Pakistan:

An Inspection Team of State Bank of Pakistan conducts an inspection of the activities of
Islamic banks in which it is checked if the instructions issued by State Bank of
Pakistan’s Islamic Banking department, guidelines of Bank’s own Shariah Board and
other Shariah requirements are being complied by the Islamic bank.

The comprehensive Shariah Governance system, as explained above, is applicable on

all Islamic banks of Pakistan and Alhamdulillah it keeps improving with time.

Conclusion

1. There is a significant difference between Islamic and conventional banking.

2. Some of the misconceptions related to Islamic banking arise due to lack of
awareness.
3. The intrinsic asset/business risk has to be borne in Islamic banking unlike
conventional banking.
4. The edifice of Islamic banking is based on the cornerstone of elimination of
interest (riba) and other prohibitions in Shariah.
5. The compliance of Shariah principles in Islamic banking is not just a baseless
claim. Instead, it is backed by a Shariah Governance System having solid
foundations.

Our Responsibility

Now that we have understood the need and importance of Islamic banking, come
and let us resolve with BankIslami that:

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Deen Connect is an Islamic knowledge and awareness program
oěŽred FREE OF COST under the guidance of authentic Shariah
Scholars.