Ever heard the words “Mudaraba” and “Murabaha” and got puzzled? Well, these are terms used in the Islamic Banking System. Islamic banking functions in harmony with the rules of Shari’ah, known as Fiqh Al- Muamalat, which means Islamic rules on transactions.
Today, let us try to know some basics of Islamic Banking System.
Why Interest is not allowed in this system?
Firstly, one important point to consider about Islamic Banking System is that, it is based on the idea that, money is not a product, because it cannot be consumed directly and hence money can be sold and bought like other product (used as interest). What Islamic Scholars agreed was that money is a means of exchange. It is not destined to be a source of income itself. It stresses the idea that one cannot make money just with money. For examples, if anyone lends money and make money off the money, he have deviated from the basic concept of money which is a means of exchange. And you have made it an end. As I said earlier, as according Islamic Banking System, money cannot solely used as product. It cannot be used as end. And therefore, earning from interest is banned here.
Secondly, Islamic Scholars also agrees that, banking system with interest remains on the absolute favor of the lender that is the Bank. According to them it gives banks an incentive to lend money without fear of loss. There this system of banking, strives to divide the risk as 50/50 between the borrower and the lender, increases the money with transfer of account from hand to hand rather than setting a fixed amount for the borrower to pay.
How Islamic Banking System works without interest?
Well, I will discuss it this through explaining two different banking methods.
This is a contract made among two parties: one which gives the whole capital for the project and other using its business skills, manages the project. Profits arising from the project are distributed according to a preset proportion. Any losses accruing are stood by the provider of capital. The provider of capital has no control over the management of the project. Here, when Islamic Bank participate with money in client’s (for them, partner) business, it shares profit with its partner, rather than charging interest.
And when deposit is put in any Islamic Bank, the deposit is treated as equity investment and depositor enjoys profit from it. This is how, instead of making a client act as a depositor, Islamic Banking system goes into a business with the client, making him/her a partner.
Now, what happens when you need a loan to buy something? Well, in this system, the Bank itself will buy the thing first and then sell it you later on profit. This is the concept upon which Murabaha stands upon. Here instead of charging interest, the Bank is again getting into a business first with the manufacturer or seller of the product first and then resale it to the client (their buyer). Here Bank is increasing money through transfer of accounts from hand to hand rather than directly charging extra money (interest). Here the client is repaying money to the bank, rather he/she is buying it.
Although Murabaha is popular as it is easy to implement. But due its apparent similarity with conventional banking system, people trust more the Mudarabah method than Murabaha. But method may be used based on the needs of the clients.