What’s so different about Islamic banking?

Keeping those savings and investments halal.

PHOTO: Reuters

Islamic banking is a financial system that is based on shariah law, which is Islamic law, and is based on the ethical values of Islam. In Singapore, many Muslims are given the opportunity to invest and save their money in accordance with Islamic law. In fact, Singapore is one of the top 15 countries for Islamic banking.

PHOTO: Islamic Arts & Architecture – Arab merchants trading

What’s the difference?

In Islamic banking, all transactions are interest-free because interest is considered haram or forbidden in shariah law. To add, profits and losses are to be shared among all parties involved in a particular transaction. These two principles form the foundation of Islamic banking.

Muslims must also make ‘ethical investments’ which mean they cannot make investments in businesses or industries that deal with haram items or actions like alcohol, pornography and gambling. As gambling is forbidden in Islam, speculation of stocks or risky investments are not allowed in Islamic banking.

To ensure this, Islamic banks will work with a committee of Islamic scholars to ensure their financial products are in line with the ethical principles of Islam.

How does it work?

Since interest is forbidden, no interest is gained when Muslims choose to save with Islamic banks. However, the bank may offer a hiba, or gift, to the account holder instead. This gift can be of any value and is not pegged to a fixed rate or amount and is considered a privilege for the account holder.

This idea applies in the reverse manner as well. The banks are not allowed to deduct any money from your savings. However, fees such as administrative charges or penalties need to be collected directly from the account holder.

This applies to other financial transactions such as loans too. Basically, there should not be any extra or hidden costs apart from the principal amount.

So how do Muslims gain from investments?

Muslims can purchase commodities from Islamic banks and then sell them back at a marked-up price after a certain period. This is known as murabaha.

Another way would be to purchase sukuk, Islamic bonds. Instead of lending money, as practised when purchasing conventional bonds, shares of an asset are purchased instead. A share of the profits generated by the assets will then be transferred to those who bought sukuk.

Then do the banks even earn?

PHOTO: Maybank

The short answer is yes. It would be unsustainable for Islamic banks to continue running if they do not earn from their financial services or products. So instead of charging interest, Islamic banks participate in equity participation systems. Loans are repaid back to the bank without interest but a share of the borrower’s profits are given to the bank. However, if the borrower defaults on the loan or earns no profit, the bank does not gain as well.

The Islamic banking system has been practised since the 7th century and spread across the Mediterranean and parts of Europe. However, it only resurfaced in the modern world in the 1960s. Since then many banks have integrated Islamic banking into some of their financial instruments. Muslims in Singapore can be rest assured that there are many options offered by banks such as CIMB and Maybank here to save or grow their money in a halal manner.

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