Principles of Islamic Banking

* Principles of Islamic banking

Islamic banking refers to a system or banking activity that is consistent with the Islamic jurisprudence [arab. fiqh] based on the principles of the Sharīʿah. Literally, it may be translated with “Path to the water of source”, rendering the “right” way that Allah has carved out for all Muslims. Main sources of the the Sharīʿah are the Qur’an and the Sunnah. Basic aims of the Sharīʿah are the spread of wisdom and welfare through transferring faith including beliefs and practices. In addition, in the past centuries Islamic religious scholars and jurists have been developing its practical application [arab. fatwa] to a system of instructions; some of them find their way into the constitutions of Arabic countries like Kuwait. Today Islamic jurisprudence is a code of conduct that on the one hand regulates the relationship between Allah and the mankind [arab. ʿibādāt] and on the other hand the economic and interpersonal relationship between individuals [arab. mu’amāt].

Since the entire legal framework of Islamic banking is codified in the Sharīʿah, every Islamic bank in the GCC region and the majority of the remaining Islamic banks worldwide have an in-house Sharīʿah -board that audits the compatibility of the banks’ products and services with the restrictions imposed by the Islamic law. In the following, the main principles of Islamic banking are explained.

* Prohibition of riba, gharar and maysir

(Qur’an 4:161)

The first and most important feature of Islamic Finance and moreover of Islamic commercial law is the prohibition of riba [arab. ribā]. Literally translated, it means “addition” or “process” of growth, whereas the technical meaning of riba is the charging and receiving of any kind of interest. The rationale is that a financial system involving interest leads to an unjust distribution of income in society. The Qur’an does not give a clear definition of riba, but as outlined in the quote above, the usurious character of...