ABSTRACTThe sometimes deal with funds in a non-Islamic or

ABSTRACTThe purpose of this document is to identify the key differences between worldwide banking and the Islamic purpose of banking. This is an important societal problem as many Muslims do not know the real, Islamic way of banking and often go astray managing their money through modern banks, which sometimes deal with funds in a non-Islamic or ‘haram’ way. Modern day banking depends on person to person and account to account. These accounts can handle deposits, loans, and many other transactions – even those online. The origin and the basis of modern banking is discussed, and these will be further explained in the following document. In addition, the topic of interest money is touched upon and how it is managed by banks is discussed. Onwards, a study of Islamic banking was introduced and its many features including its main philosophy, origin, and its modes – with references to Qur’anic Ayah and Hadith. It is also explained how Islamic banks earn profit without dealing in interest (Riba’a), including a contemporary view of Islamic banking in 2018. Conclusively, the differences between these 2 major types of banking are made apparent and criticized, and it is decided which type of banking is better – the Islamic method. The research was mainly done on the internet and most of the bibliography will include citations from different URLS and websites specializing in this topic.3MODERN DAY BANKING SYSTEMSHistory:Modern Day banking first started with the barter system with the merchants 2000 BC Assyria and Babylonia and further spread to ancient Greece and the Roman Empire. This was then taken to Europe and the first bank was set up in Italy known as the Medici Bank in 1397. The first type of banking was Fractional Reserve Banking and it was started by goldsmiths in the 17th and 18th century, in which the goldsmiths lended money to people on behalf of others. The Bank of England was the first bank to ever issue permanent bank notes – in 1695 – followed by the Bank of Scotland who started the first issues of over-drafting.1Etymology (Origin):The word bank came from Middle French – Banque, Old Italian – Banca (meaning ‘table’), Old High German – Banc (meaning ‘bench counter’).2What is a Bank?A bank is a financial institution that accepts deposits from the public and creates credit. As they are important to a countries financial stability, they are kept regulated through the government. These banks mostly use a system called fractional reserve banking (see above – History). In this type of banking the banks hold “liquid assets equal to only a portion of their1 Wikipedia, Bank, History, https://en.wikipedia.org/wiki/Bank2 Wikipedia, Bank, Etymology, https://en.wikipedia.org/wiki/Bank4current liabilities.3 Modern banks are also held to minimum capital requirements as they are part of the government.Banks are just a small part of the financial world, alongside investment banks, insurance companies, and depositors etc. Banks are also the most “highly regulated businesses in the world”, as they deal with trillions of assets worldwide. Almost every age 18+ adult has a bank account and student accounts make up for almost 1/4th of the accounts in the world. 4Different Types of Banking Services: 51. Individual Banking – in which banks help the public individuals manage their money. This can include checking accounts, savings accounts, debit/credit cards, and insurance.2. Business Banking – these services are for those who keep their professional ad private accounts separate, especially those who run large businesses and collaborate with banks to keeps a record of their financial incomes and expenditures. These services are the same as those of individual banking except for the fact that it might also contain business loans and cash management.3. Digital Banking – these banking services are mostly online and can be accessed through the internet. For the security of digital banking, one usually gets an email or a text message to confirm their transactions but even with those, digital banking can be dangerous as there is malicious software that can steal one’s information. It is, however,3 Wikipedia, Bank, https://en.wikipedia.org/wiki/Bank4 Stephen D. Simpson, CFA, Banking Systems, https://www.investopedia.com/university/banking-system5 Different Types of Banking Services, https://www.localfirstbank.com/content/different-types-of-banking-services5easier for the general public as they can get online statements and pay bills over the internet.4. Loans – banks offer various offers of money management through loans and these can include personal loans, home equity loans, student loans etc.How Banks Make Money? 6Now coming to the real question of how these banks actually make money, because it seems like all they are doing is just storing money and then giving it away. Most banks make money by “lending money at a higher rate than the cost of the money they lend”. They collect interests on loans, credit, and short-term borrowing the total net income for the bank is referred to as ‘spread’.Deposits: Most banks make money on the deposits of the public. These include accounts like savings accounts, security deposits, and checking accounts. When a person withdraws a certain amount from the bank, they have to pay ‘interest’ to the bank as they have been safe-keeping their money. In some accounts, the interest rates are very low, while for some they aren’t there at all; it depends from bank to bank.Share Equity: Share equity is, in its most common terms, the amount of shareholder capital a bank holds – how many companies and organizations have invested in a bank. If all6 Stephen D. Simpson, CFA, The Banking System: Commercial Banking – How Banks make Money? https://www.investopedia.com/university/banking-system/banking-system3.asp6else fails – the deposits and interests – the bank will still have its shareholder equity to capitalize on and make money since people have bought the shares in the bank.Debt: Banks also raise capital through debt issuance although it’s not their primary source of income. Debts are usually used to smoothen the curves in some banks funding problems.Use of Funds – Loans & Consumer LendingLoans: when the bank gets its interest from people drawing out their money, it usually uses it as loans to give to people who in turn will pay interest for these loans. This makes a vicious cycle for the earning of banks as they keep on earning through interest. How banks give loans is another matter entirely. They check for the credit worthiness of a specific individual and then think upon the reasons of the loan being taken. It is preferred to have a physical asset which is bought through the loan money so that the bank can usurp that if the loaner is not able to pay his/her debt at the end of a period.Consumer Lending: it is a type of fund usage which is centered on individual and household consumers and not companies or organizations.7 It works the same way as business loans do but one must give evidence or proof of their financial situation before they can take advantage of consumer lending.7 Neil Kokemuller, What is Consumer Lending?, April 28th, 2010, https://www.sapling.com/6400887/consumer-lending7ISLAMIC BANKINGIslamic Banking is a type of banking in in which banks implement Islamic Law – Sharia ‘a – and base it on rules of Islamic economics.8 Sharia ‘a is the divine guidance provided by our Lord and Creator – Allah (S.W.T.) – through Hadith and the Qur’an, and those opinions as given by scholars well versed in the Holy Books (The Torah, Injeel, Qur’an to name a few) and Hadith. Sharia ‘a prohibits the dealing of Riba (Interest) and having business with organizations that deal sinfully such as those dealing with pork, gambling, and alcohol. In Islam, all the transactions ate interest free and the operations based on sharing risks that may arise on trading or contracts. As is said the Qur’an: “O those who believe; fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your principal; neither will you do wrong nor, will you be wronged”. 9 Similarly, a Hadith states: It is reported by Harith ibe Abi Usamah in his Musnad that Sayyidna Ali Radi Allahu Anh reportedly referred that the Holy Prophet (S.A.W.) said: “Every loan that derives a benefit (to the lender) is riba.”10Philosophy of Islamic BankingThe philosophy of Islamic banking takes the lead from Islamic Shariah. According to Islamic Shariah, Transactions involving interest/riba, Gharar and Maiser are prohibited. Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of8 Wikipedia, Islamic Banking and Finance, https://en.wikipedia.org/wiki/Islamic_banking_and_finance9 The Qur’an (2:278)10 Sahih Bukhari8Islam). Islamic banks focus on generating returns through investment tools which are also Shariah compliant. Islamic Shariah links the gain on capital with its performance.1. Riba: An increase sought over the principal of a loan or debt and implies any excess compensation without due consideration (consideration does not include time value of money).2. Gharar: Excessive level of uncertainty or ambiguity created due to the lack of information or control in a contract.3. Maiser: Game of Chance or speculation.The Origins of Islamic BankingIslamic banking dates to the 7th century when Prophet Muhammad used to go to different countries to trade for his wife – Khadija (R.A.). He sued the same principles that many people nowadays use for contemporary Islamic Banking. Since Islamic banking was in use before the era or modern banking started, it can be said that Islam provided the basis of banking for the postmodern world.11Modes of Islamic Banking 12There are in general 3 basic modes of Islamic Banking and those are Trade based, Lease based and participatory modes. Under these come the following:11 Islamic Banking, https://www.investopedia.com/terms/i/islamicbanking.asp12 http://summitbank.com.pk/wp-content/uploads/2016/06/IB_FAQ_English.pdf9Trade Based:1. Murabaha: A Sale – Purchase contract on mutually agreed profit in which the seller disclosed the cost and profit separately.2. Salam: A Sale- Purchase contract where the seller agrees to supply goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract.3. Istisna: A Sale- Purchase contract for manufactured goods / constructed assets, whereby payment is generally made in advance. The goods are eventually sold in market to earn profit.Lease Based:1. Ijarah: A Rental contract where Assets, Services / Benefits are rented/ rendered over a period.2. Ijarah Muntahia Bittamleek: A form of Ijarah which includes a promise by the lessor to transfer the ownership of the leased asset to the lessee, either at the end of the lease term or in stages during the term of the contract.3. Diminishing Musharakah: It is a form of partnership in which one of the partner’s promises to buy the equity share of the other partner gradually until the title to the equity is completely transferred to him. Till the time ownership is completely transferred the other partner pays rent for the usufructs of the Asset in his/ her use.Participatory:1. Musharaka: A relationship established under a mutually agreed contract between the parties for sharing of profits and losses arising from a joint entrepreneurship or venture.102. Modaraba: A participatory mode of finance where one party provides the capital (Rab-ul-Maal) while the other provides human capital (i.e entrepreneurship and efforts) needed for the economic activity to be undertaken. Profit earned is shared between the two parties on a pre-agreed ratio, while loss is borne only by the provider of the capital.Earning in Islamic BanksTo earn money without charging interest, Islamic banks use equity-participation systems. This means that if a bank loans money to a business, the business pays back the loan without interest, but it gives the bank a share in its profits earned through whatever endeavor they did with the loan (If the business defaults on the loan or does not earn any profits, the bank does not receive any profit either). Another way practiced in Islamic banking is that rather than lending a customer money to buy a house, the bank will buy the house itself. The customer can then either buy the house back from the bank at an agreed above market value and pay back in instalments.11COMPARING THE TWO TYPES OF BANKING 13Modern day banks run on manmade rules while Islamic banks run on Shariah. While modern banks regard money as a commodity, Islamic bank regard them as a medium of exchange. Modern banks make money through interest and can charge additional money in the case of defaults while Islamic banks make money by providing services and getting paid for it and they do not charge extra money to defaulters as it is haram. Modern Banks do not discourage the usage of haram substances while Islamic banks do.While they make the same money, the difference between Islamic Banking and Modern Banking is worlds apart. This is because the main basis of the difference in these types of banking is that in Islamic Banking, it is the transaction that make the exchange Haram or Halal. In Modern Banking, it’s the actual substance bought through the money that justifies it. This can be seen in the fact that in Islamic banks, the bank makes the transaction for one, and then they can be paid, and in modern banking, the loans and lending is based on what the money is being used for (showing that modern day banking is more focused on the object rather than the transaction).13 http://summitbank.com.pk/wp-content/uploads/2016/06/IB_FAQ_English.pdf

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