What makes an Islamic bank an Islamic bank? Its adherence to Islamic banking principles. The Qur’an, which Muslims believe to be the exact Words of God as revealed to the Prophet Mohammed, sets out the principles of Islamic finance. These principles can be narrowed down to four concepts.
1. Prohibition of Interest or Usury
Most importantly, the charging and the receiving of interest is strictly forbidden. Interest is commonly known as riba or usury. Money, on its own, may not generate profits. When riba infects an entire economy, it jeopardises the wellbeing of everyone living in that society. When investors are more concerned with rates of interest and guaranteed returns than they are with the uses to which money is put, the results can only be negative.
2. Ethical Standards
When Muslims invest their money in something, it is their religious duty to make sure that what they invest in is good and wholesome. Islamic investing must seriously consider the business to be invested in, its policies, the products it produces, the services it provides, and the impact that these have on society and the environment. Muslims must take a close look at the business they are about to become involved in.
Islam has rules and regulations on how Muslims should participate in financial activities. For example, in share trading or the securities market, we must scrutinise the activities of the companies to establish whether they are in line with Shariah (Islamic law).
3. Moral and Social Values
The Qur'an calls on all its adherents to care for and support the poor and destitute. Islamic financial institutions are expected to provide special services to those in need. Going beyond mere charitable donations, Islamic banks are involved in social projects. They also offer profit-free loans or Al Quard Al Hasan.
For example, if an individual needs to go to hospital or wants to go to university, we would usually give them Quard Al Hasan for a short period of about a year and do not charge them anything for that.
4. Liability and Business Risk
This is the overarching concept of fairness - the idea that all parties should share in the risk and profit of any business endeavour. To be entitled to a return, a financial provider must either accept business risk or provide a service (such as supplying an asset). Otherwise, the financier is, from a Shariah point of view, not only an economic parasite but also a sinner.
This principle is derived from a saying of the Prophet Mohammed (May Peace be upon Him): "Profit comes with liability". One is only entitled to profit when one bears the liability, or risk of loss. By linking profit with the possibility of loss, Islamic law distinguishes lawful profit from all other forms of gain.
Making sure Islamic financial principles are followed
Each Islamic financial institution must have an independent advisory council known as a Shariah Board. Bankers, lawyers or religious scholars can be members of a Shariah Board provided they are trained in the Islamic law (Shariah).
External auditors are required to check whether Islamic banks comply with Shariah rules as defined by their Shariah Board, and act in accordance with Shariah standards set our by the Accounting and Auditing Organisation for the Islamic Financial Institutions.