The peculiarities of Islamic banking and finance Essay

Islamic banking is defined as an interest free system based on profit & loss sharing (PLS) principles. It came to the picture in the late twentieth century and has grown tremendously in the last twenty years. This growth can be connected to the unrestricted flow of capital and the awareness by Muslims of the result of interest based transactions in their religion. The revolutionary divergence from conventional banking system to the interest free Islamic banking is exemplified by a visionionary thought to move from debt based financial institution to an equity based arrangement. In this regard Bhatti and Khan (2008) argue that Islamic banking is a growing field adding more moral practices and tools and systems to global economy. In addition, Siddique (2002) highlighted that Islamic banking is dominated by PLS which acts as a shock absorber for any differentiated outcomes on the asset side of the balance sheet. In contrast to the above, Abdullah and Dusuki (2006) point out that an ideal structure of Islamic banking based on PLS theorem proves to be a delusion. Similarly, Khan (2004) says that only a small portion of the assets of Islamic banks (around 5 percent) consists of loans based on a original PLS system. The rest is mainly dominated by the debt based mode of financing, such as Murabaha contracts. Adding further to the dilemma, Ismail (2002) argues that in Islamic banking practices equal importance is placed on debt based contracts. Similarly, Chong and Liu (2007) highlight both debt and equity based financing issues in Islamic banking. They debated that Mudaraba, which is imagined to be interest free, is formulated similarly to the conventional banking deposits. Other studies, such as Sadaar (1982), Siddique (1985), Ahmad (1994), Haron (1996),Ahmad (2000), Chapra (2000), Siddiqui (2002), and Dusuki and Abdullah (2006) argue about the role played by Islamic banks in society.

These studies report that Islamic banks not only offer profit and loss based products but also promote welfare in the society. On the opposite, Lewis and Algaud (2001) and Satkunseigaran (2003) propose Ismails (2002) model, which stresses that Islamic banks should try to maximize profits like normal commercial banks as long as it is done according to Islamic teachings.

1.2. Problem Statement

Modern commercial banking is based on interest which is contradictory to the Sharia (Islamic law), thus for all the believers in Allah (SWT) dealing with these institutions do not suit well. Over the time role taken by the banking sector has become crucial for the growth and development of economies and societies (a shared goal of humanity). Ann ordinary man who is the believer of any revealed religion including Christianity, Hinduism and Islam is very much in a state of bewilderment. On one side, is the very craving dream of development while on the other hand is faith. Moreover there is a sufficient number of experts who think and expound that prohibited means usury (additional amount charged on consumption loans) and not interest (additional amount charged on production loans) being