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Banking Operations

This paticular section provides resources on the operations of Islamic banks, central banks and services provides by these institutions. 

Lessons

Issues Faced by Islamic Banks

The Islamic banking industry has grown rapidly over the last few years. However, an examination of Islamic banks and the wider industry, raises a number of issues.

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Islamic banks as financial intermediaries

In the last 20 years, commercial banks share of US financial assets has declined to 24.5% from nearly 40%. New technologies of communication and computerized financial transaction made it possible for many savers to bypass commercial banks and directly reach out to users of funds. This diminishing role of banking is, effectively compensated for by growth of financial markets (money and capital markets). As their ability to make their own credit judgment improves, more and more savers prefer to eliminate the “middleman” , by directly taking the risk of borrowers, than the risk of banks. This is exactly the idea of Islamic banking. An Islamic bank is a financial intermediary. However, its operation is not based on a “borrower-lender” relationship with savers. Alternatively, it functions as an agent procuring investment opportunities to its depositors, where they directly take the investment risk. To prevent adverse selection and generate incentive compatibility, this agent does not get fixed fees for its fund-management. rather it is compensated on the basis of actual profits of these investments.

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Shari’ah Maxims Relevant to Islamic Banking

A Shari’ah maxim is a set of principles determined with precision, derived by jurists from the known rules of Shari’ah. They present an exposition of the spirit of a legal text. It is intended to facilitate the application of Shari’ah rules in diverse situations in human society.

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The Role of Shari’ah Advisors in Islamic Banking

One of the most distinguishing features in Islamic banks is the fact that they are always advised by experts in Islamic Shari’ah. Because the raison d’être of Islamic banks is the desire to follow the injunctions of Shari’ah in finance and investment, it became essential to give assurances to the public, particularly savers, that the bank is getting professional advice in that matter. Furthermore, since it was difficult to find bankers who are also well versed in Shari’ah, banks find it pertinent to affiliate to the management a Shari’ah board. Not all Islamic banks have a Shari’ah, board, nevertheless. Some, may have only one advisor. Others may seek the advice of many, but only when the need arises. The majority, however do retain a Shari’ah council which meets occasionally and clear model transactions and contracts, and issue an annual statement attesting the adherence of the management to the advice and instructions of the Shari’ah board vis the religious aspects of the business.

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Limits to Shari’ah board participation in the day to day business of an Islamic bank

A Shari’ah board is always a consulting body. However, Islamic banks differ in how much power is bestowed upon such body. Some Islamic bank may grant the Shari’ah board an authority to do Shari’ah auditing to all branches and offices of the bank, making sure that strict adherence to the set procedures is attained. A direct relationship between the board and the outside auditors of the bank may be established to facilitate Shari’ah board investigation.

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Handling Delinquency and Default in Islamic Banking

Failure to pay finance obligations when due is not uncommon even in Islamic banking. The fact that mudarabah and musharakah, which are not debt based modes of finance, are used doesn’t ghard an Islamic bank against this possibility. The problem is that charging a penalty (late charges) is not permitted in Islamic Shari’ah. Only actual cost f debt collection may be imposed. The reason is that such penalties fall under the definition of usury in Islamic jurisprudence. This is quite problematic in Islamic banking because it makes delinquency “costless” to bank clients. The problem is many fold: firstly it prevent to the Islamic bank from being compensated for lost time and opportunities of profit. More importantly, however, it creates an incentive for the clients not to pay on time. Furthermore, it increases the cost of finance in an Islamic bank compared to conventional banking. This is because the effective cost of delinquency would have to be born by those who pay their obligation with delay. Such people will refuse to pay the higher cost, which means that the Islamic bank will end up with the “bad risks” clients.

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Tawarruq based credit card

The objective is to issue a card that is Shari'ah compliant based on the structure approved by BSF Shari'ah board and at the same time can be fitted into the already existing infrastructure both locally and internationally.

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