There is no standard way of defining what an Islamic bank is, but broadly speaking an "Islamic bank is an institution that mobilizes financial resources and invests them in an attempt to achieve predetermined islamically-acceptable social and financial objectives. Both mobilization and investment of funds should be conducted in accordance with the principles of Islamic Shari'a".
- Prohibition of Interest or Usury
- Ethical Standards
- Moral and Social Values
- Liability and Business Risk
1. Prohibition of Interest or Usury
The principles of Islamic finance are established in the Qur'an, which Muslims believe are the exact Words of God as revealed to the Prophet Mohammed. These Islamic principles of finance can be narrowed down to four individual concepts.
The first and most important concept is that both the charging and the receiving of interest is strictly forbidden. This is commonly known as Riba1 or Usury. Money, on its own, may not generate profits. When Riba infects an entire economy, it jeopardizes the well-being 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.
Adherents of Islam believe that the Qur'an is the final book of God's word following both the Torah and the Bible. As a result, there are a number of similarities between the Islamic, Christian and Jewish faiths.
Quoting Shaikh Saleh Abdullah Kamel, Chairman and Founder of Albaraka Banking Group; Usury is forbidden in all the three religions, Judaism, Christianity and Islam, but it is the people who forget the rules of Allah. All societies, nowadays - Muslims, Christians and Jews - deal with Usury.
2- Ethical Standards
The second guiding principle concerns the ethical standards. When Muslims invest their money in something, it is their religious duty to ensure that what they invest in is good and wholesome. It is for this reason that Islamic investing includes serious consideration of 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. In other words, Muslims must take a close look at the business they are about to become involved in.
In all facets of the financial system, Islam has certain rules, certain regulations as to how Muslims should go about participating in these activities. For example, in share trading or the securities market, Islam looks at the activities of the companies, to establish whether or not the companies are involved in activities which are in line with Sharia'a.
3- Moral and Social Values
The third guiding principle concerns 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. This is not confined to mere charitable donations but has also been institutionalized in the industry in the form of profit-free loans or Al Quard Al Hasan.
An Islamic bank's business includes certain social projects, as well as charitable donations. Islamic banks provide profit-free loans. For example, if an individual needs to go to hospital or wants to go to university, we give what is called Quard Al Hasan. This Quard Hasan is normally given for a short period of one year and the Islamic bank does not charge anything for that.
4- Liability and Business Risk
The final principle concerns the overarching concept of fairness, the idea that all parties concerned should both share in the risk and profit of any endeavor. To be entitled to a return, a provider of finance must either accept business risk or provide some service such as supplying an asset, otherwise the financier is, from a Sharia'a 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". What this means is that one becomes entitled to profit only 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.
In order to insure that these principles are followed, each Islamic institution must establish and provide itself with an advisory council known as a Sharia'a Board. The members of Sharia'a Boards can include bankers, lawyers or religious scholars as long as they are trained in the Islamic law, or Sharia'a.
In 2001, the Industry witnessed a remarkable development in this regard by the initiative of the Accounting and Auditing Organization for the Islamic Financial Institutions or AAOIFI. At that time, AAOIFI's standards were enhanced to include elements that aim at broadening the role of the external auditor. Now according to these new developments the external auditor is also required to look for compliance with Sharia'a rules as defined by the Sharia'a supervisory board of each bank and in accordance with the Sharia'a standards AAOIFI has begun to issue.