Muslim jurists and scholars generally accepted the used and function of the modern banking system and modern form of money as one of the economic gears in today’s world. In Islam, money is merely as tools of potential capital and not capital by itself. A risk must be undertaken to justify a return, for this reason, money has to be transformed into a productive use.
It is against the Islamic rationality to stock up on money (Quran; 9:34 and 35). Thus, money kept as saving and unused will be charged with zakat (alms). Zakat (alms) is an obligatory charity and is a levy on certain categories of wealth in Islam. It follows that savings must be put to good use. To transform money into productive use, it requires the services of someone else such as entrepreneurs. One who cannot go into business himself can supply funds bases of partnership or on a profit and risk sharing. Therefore, the money and Islamic banking sector somehow should stand for contributing to the achievement of major economic goals following the Islamic worldview.
The practices of Islamic financial institutions proceeded with the basis that it must be derived based on the shariah principles. The major principles that apply to shariah compliant financing activities are:
1. Ban on interest for the reason that it resembles the characteristics of riba or usury. In interest-based forms of finance, there is a distinction between acceptable interest and usurious interest. On the contrary, under the Islamic law, any level of interest is usurious and prohibited. As a replacement is the approval for equity-based financing (investment) with the concepts of sharing of profit and risk and the trade-based (al-bay) financing instrument for financial transaction.
2. Prohibition on any transaction involves speculative activities, ambiguous and uncertain activities, and the trading of financial risk. Ambiguity in contractual terms, conditions, and transactions is not allowed unless all of the terms and conditions of the risk are clearly understood by all parties involved in a financial transaction.
3. Fulfilling the concept of fairness and justice – In Islam, parties that are involved in a financial transaction must share both the associated profits and risks in order to fulfil the concepts of fairness and justice.
4. Ethical investments and consumption spending – Project and consumption financing must be within the moral value structure, more efficient, more cautious and selective in project selection. Investment and consumption that are prohibited by the Qur’an, such as alcohol, pornography, gambling and pork- based products are disallowed.
5. Asset-backing financial transactions – Each financial transaction must be tied to a “tangible and identifiable underlying asset.” Under shariah, money is not tangible and not considered or classified as an asset, thus, may not earn a return.
In the case of interest-based banks, their operations are primarily based on the interest instrument. The interest-based banks pay interest on the deposits and charge interest on the loans. When interest is imposed on the loan and deposits, money by itself is independent of any labour, effort, or bearing of any risk and it increases over time. Since Allah (swt) unambiguously declared nothing could be having without effort or labour (Quran, 4:32), thus, the increase realised through exploitation of labour, goods, or property is against the Islamic principles.
Unjust appropriation of others’ wealth, by whatever means and methods, is forbidden from the Islamic view (Quran, 2:188 and 4:29). In view of the fact that injustice lies at the root of interest-based instruments of all undesirable business conduct, therefore, the payment and receipts of interest are strictly prohibited in Islam regardless of the purpose for such loans or deposits and regardless of the rates at which interest is charged or given.
Interest, definitely involves unlawful consumption of others’ wealth. It is therefore, abhorrent and evil. The Holy Quran (Quran: 2:275-281; 3:130-132; 4:161; 30:39) and the hadith had explicitly prohibited usury. The need for transparency is above all and an important shariah consideration. Any form of concealment, fraud or attempt at misrepresentation violates the principles of justice and fairness in shariah as mentioned in the Quran, in among others, verse 135 in chapter An-Nisa’ (4) and verses 1 to 3 in chapter Al-Mutaffifin (83).
Another major concept that governs the behaviour of Islamic bank is the concept of trustworthiness (amanah). Trustworthiness is a very significant concept in Islam. Trustworthiness, as prescribed in the Quran and sunnah denotes performing all obligations and responsibilities (Quran, 4: 58; and Hadith: “And there is no faith in him (somebody) who is not trustworthy”). Thus, banks of their role as financial institutions should always be transparent in their operation to fulfil the concepts of trustworthiness (amanah) to the depositors as the owner of funds and the fund provider. The Islamic banks not only safeguard and manage depositors’ money but they also play the role as the trusty to the fund owners and accountable for any of their action.
Another important fact of the Islamic bank operation is adhering to the instruction in the chapter Yusuf (12): verses 46 to 49 that is the guideline in managing its assets and liability management:
“ O truthful Yusuf, explain to us, seven fat cows which seven lean ones devoured, and seven green ears, and seven other dry, that I might return to the people that they may know (46). He said, “For seven years you shall sow continuously, then what you reap leave 5 it on the ear, except a little whereof you eat (47). Then thereafter there shall come upon you seven hard years, in which you shall devour all that you have reserved for them, except a little you keep in store (48). Then there shall come after that a year in which the people shall have rain and in which they shall press (fruit & oil) (49). (Quran; Yusuf (12):46-49)
Those verses of the Quran instructed every individual and organisation to increase the size of contingency reserve, provision for loan losses, and capital provision in the event of growing economic trend. It is significant for the economic units to increase the contingency reserve, provision for loan losses and capital during prosperous economic condition for precautionary measures. In the event of slower economic growth every individual and organisation are instructed to spend the contingency reserve, provision for loan losses, and capital. Increasing the spending during economic slowdowns will help to boost up the economic activities back to its growing track.
The Islamic bank operation essentially performs the same functions as those of interest- based banking systems as financial intermediaries even though the principles of shariah govern its operation. The Islamic banking system aim is to meet the requirement of those who ask for capital for specific investments. It provides the financing of working capital, industry, agriculture or any other lawful investments and services, but without
charging interest in any form. In Islamic bank operations, the imposition of interests in loans is not permissible under the prohibition of riba (usury). In the case of loans, it is riba al-Nasiah. Riba al-Nasiah is the additional amount sought on loan, usually on time bases (also known as riba al-Jahiliyyah, which is the type of riba that is expressly prohibited by the Quran).
To confer deeper, in Islam, a financial institution is not just an institution acting as an intermediary in transferring funds of the ultimate lenders to the ultimate borrowers. Al- Najjar (1983) defined the Islamic financial institutions not mere ‘houses of finance’, but rather developmental institutions ideologically based on Islamic principles. They are institutions which believe that their funds are part of Allah (swt) property, to whom all properties belong and humans as the trustees. Accordingly, dealing with those funds should be bound by the shariah principles. They believe that all the services should be based on moral and money has a social function, therefore, it should be used for the welfare of society. They also believe that the Islamic financial institution functions do not confine merely to the financial and economic affairs of society but are also concerned with social and educational affairs.
From the above statements, the Islamic concept of financial institutions is not only concerned with financial or economic affairs alone but as a social and educational affair of the society as well. Thus, the Islamic injunctions on the economy and commerce are to secure the rights of the public and maintain the solidarity of society. It seeks to inculcate morality in business and specifically, the most important agenda is to make the law of Allah (swt) supreme in all types of business enterprise.