Financial Institutions - Islamic banking and how it can be distinguished from the mainstream UK system

Introduction:

What I am going to be discussing

What is Islamic banking, include a brief history

What parts of Islamic banking I will be discussing and how it can be distinguished from mainstream UK banking.

Islamic banking has emerged because of the gap within the world market to allow Muslims to bank within the guidelines of their faith from a small experiment in a village in Egypt to becoming very successful and even entering Western markets with London being the European capital of Islamic banking. During this essay I am going to be giving a brief history of Islamic banking and a general overview of some of the products they offer one of these being the two different types of mortgages and then lastly I will compare Islamic banking to the mainstream UK system and then finally conclude these findings. Just to clarify I will be using a few Islamic terms throughout this essay but have included a brief definition where possible and one of the main terms I will be so frequently referring to is the word 'riba' which is an Islamic translation of increase and refers to interest which is forbidden in Islamic law and therefore lays the foundations of Islamic banking.

"Under Islamic law, Sharia law defines the framework within which Muslims should conduct their lives"[1]. Islamic banks must not invest in industries which are also prohibited by Sharia law such as alcohol, betting and pornography this allows Muslims to abide to the Quran and live an ethical life.

The first Islamic bank was set up in the late 1960's in Egypt to fulfil the needs of Muslims who wanted to bank but still live by Sharia law. An Islamic bank is not a religious institution but caters for the needs of the Muslim and is expanding to non-Muslims who see Islamic banking as an alternative to commercial banking.

The first Islamic bank was set up in 1975[2] and in the last five years has seen a steady increase in Islamic finance not only in the middle-east but also the western world. The first Islamic bank to be opened up in the west was authorised by the Financial Service Authority (FSA UK) in 2004[3] and shortly after opened in the UK.

Islamic banking is quickly growing all over the world with it being the preferred method of banking for one fifth of humanity and is one of the fastest growing industries[4].

The main fundamental of Islamic banking is set upon the foundations of profit-sharing instead of being interest (riba in Islamic) based which we are all so familiar with in mainstream Western banking systems.


Chapter 1:

Does Islamic banking have a structure? If so, how does it work?

In Islamic banking depositors are only able to withdraw their capital if liquidity is available.

Depositors are able to get one hundred percent of their capital back without causing negative effects in the economy or help from the central bank because of the higher liquidity ration held by Islamic banks compared to commercial banks. Islamic banks do not count capital from their depositors as their own but instead the bank simply acts as an agent and manages this capital, for this reason this capital is not included on the banks balance sheet. Investment tends to be in BBA and Murabahah. Investing in these industries guarantees returns because of the competitive market rates.

Islamic law

International scope of Islamic banking


Chapter 2:

How do they handle, pensions, insurance, loans, currency and mortgages (note mortgages has two parts), etc

Murabahah is often used in Islamic banking and involves the bank agrees to sell a good to a customer at a higher price so the bank makes a profit and the customer gets the good they want (a good example being a car) in the form of a loan without being charged interest. The customer is able to settle the payment outright by paying off the loan in one go, but it is in the bank's interest to keep the instalments over a time period so they can then gain

There are two types of mortgages offered by Islamic banks firstly being the 'Ijara' mortgage; this involves the customer once they have a property in mind agreeing a price with the bank (which is usually higher than the price of the property allowing the bank to make a profit). The bank then buys the property on behalf of the customer and enters an agreement with the customer on a 'promise to purchase' basis. An agreement allowing the customer to lease the property is also entered. The customer then pays instalments of the agreed price to the bank and once the total sum of the agreed price has been paid to the bank the rights of the property is then transferred outright to the customer.

The next type of mortgage is the 'Musharaka' mortgage which is similar to the Ijara mortgage but has a few small differences. Both enter into an agreement with the bank to pay an agreed price for a property and the property is bought on behalf of the customer. In Ijara the customer pays instalments until they have paid off the total sum but in Musharaka the instalments the customer pays to the banks then transfers to a share of the property the customer then owns. Once the full amount of the agreed price has been paid to the bank the customer then owns 100% of the property.

Trading assets, Diwany, page 152

Do they lend to other banks?


Chapter 3:

Talk about UK banking

Compare mainstream mortgages to Islamic mortgages

Does Islamic and UK banks function and have the same concepts/ offer the same products and have the same structure?

One of the issues that have arisen in the UK and other Western countries was the conflict with regulations that existing financial institutions have to abide to. A problem Islamic banks face is that they couldn't offer depositors an account in which their capital wouldn't reduce in value because they offer no interest. Depositors must be able to withdraw one hundred per cent of their capital but if this capital is tied up in profit-sharing investment this could lead to loss-sharing. If the funds were to be kept safe than the capital cannot be simultaneously invested which would create no capital gain for depositors and this would place Islamic banks at a disadvantage in the market place compared to commercial banks.


Chapter 4:

Summary of what I have discussed

Do not include my own opinion


[1] FSA.gov.uk

[2] Economist.com

[3] FSA.gov.uk

[4] Thirty Years of Islamic Banking

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/financial-institutions-islamic-banking.php


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