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Offlate, a lot is being said about Islamic banking. Even Forbes magazine had one article on this form of banking.
This article from Reuters believes "Islamic finance can give early warning of debt woes".
With so much of talk going on, I tried to find out what actually is Islamic banking. The basis of this form of banking is the prohibition of Riba- (Usury - or interest). To digg further, it also does not allow your money to be invested in business declared as Haraam (illegal) in Islam. Some of them are liquor,porn industry, gambling (its always fun to gamble with other's money  ), pork food busines etc.
For the various sources, across internet I realised that this form of banking is basically a profit-loss-risk sharing form of institution. The end user also act as an investor in this form of banking, and as an investor, he is expected to keep an eye on bank policies. He is a partner in the business. It system employes the concept of participation, and, in its ideal realm, aims to work with social responsibility and social justice.
Concept and few terms can be explained as...
Islamic financial system can be explained as :
Now lets see some of the transaction under Islamic banking :
Mudaraba:
Trustee partnership based on mudaraba is
a mode of financing through which the bank provides capital finance for
a specific venture indicated by the customer. The bank, called
rabb-al-mal is the owner of the capital and the customer-entrepreneur,
called mudarib, is responsible for the management of the business and
provides professional, managerial and technical expertise for
initiating and operating the business enterprise or project. Profit is
shared according to a pre-agreed ratio. Losses if any, are entirely
absorbed by the capital provider – the bank.
Mudaraba may be of
two types – restricted or unrestricted. In a restricted mudaraba
(mudaraba al-muqayyada) the bank or the financier may specify a
particular business in which investments may be undertaken. Mudaraba
may also be an unrestricted one (mudaraba al-mutlaqa); in which case
the mudarib may invest the capital provided in any business he deems
fit.
Musharaka:
A joint venture based on musharaka
involves a partnership in which both the bank and its customer-client
contribute to entrepreneurship and capital. It is an agreement whereby
the customer and the bank agree to combine financial resources to
undertake any type of business venture, and agree to manage the same
according to the terms of the agreement. Profits are shared between the
bank and the customer in the pre-agreed ratio. Losses are shared
strictly in proportion to their respective capital contributions.
These two are equity based financing product.
Let's continue with te Shariah compliant financing
Investment (Mudaraba) Deposits:
This is the core deposit product of an Islamic bank. The product is based on the concept of mudaraba and as such, is also known as profit-and-loss sharing (PLS) deposit or participatory deposit.
It is perhaps the Islamic counterpart of the conventional fixed deposit
product that disallows withdrawal prior to a maturity period. At times
such deposits allow withdrawal, but only at the cost of foregoing the
profit share. The product is based on the concept of mudaraba.
Depending upon the degree of freedom accorded to the bank as the
mudarib, intended end-use of funds or eligibility of depositors, there
are several types of investment deposits.
General Investment Deposits:
This
is a popular deposit product of Islamic banks under which an investment
pool is established. The pool includes investment deposits of different
maturities. The funds are not tied to any specific investment project
but are utilized in different and continuous financing operations of
the bank. Profits are calculated and distributed at the end of the
accounting period, which is either three months, six months or one year.
Special Investment Deposit
This
deposit account is similar in all respects to General Investment
Deposit except that the depositor should meet the required minimum to
invest in this product. For instance, the bank may selectively accept
deposits from the government and / or the corporate customer. The modes
of investment of the funds and the ratio of profit distribution may
usually be individually negotiated. The product provides the bank with
specific authorization to invest in a particular project or trade and
the profits of this particular project only are distributed between the
bank and its customers according to mutually agreed terms and
conditions.
Diagram and definitions from :
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