Introduction :Islamic Banking

islamic bank of britain

Shariah compliance also ensures Corporate Social Responsibility (CSR) & ethical compliance. Islamic banks do not conduct business with companies producing tobacco, alcohol or engaged in business of betting, casino, nightclubs, prostitution etc. This mechanism has given Islamic banking the name of 'ethical banking' in Europe.

islamic bank of britain

The balance sheet of Islamic banks can taking financial shocks. Islamic banks are not obliged to give fixed return to their depositors & general creditors. The creditors, shareholders & depositors share & participate in the bank's business. Therefore, if incase, there is a shock on asset side (NPL increasing), Islamic banks will be able to share this loss with their depositors & shareholders.

Financing Operations of Islamic Banks

Islamic banks cannot rollover loans. Therefore, the packaging & repackaging of loans & then issuing increasingly debt securities on the back of these non performing loans cannot legally happen in Islamic Banks. Islamic banks are obliged to have backing of assets in all their investments. Therefore, Islamic banks losses even theoretically cannot go beyond the worth of the actual asset.

Diminishing Musharakah

For the provision of finance, following modes are used in Islamic banking.

Murabaha Muajjal

In Diminishing Musharakah, the customer approaches the bank for joint purchase of an asset/property. It is often called 'Diminishing Musharakah' because the possession stake of the tenant increases & that of the bank decreases or diminishes with the passage of time. The rent decreases as the possession stake of tenant increases. The share of the bank in asset/property is divided in to units. These units are bought by the customer periodically until they has bought all the units. After the customer has bought all the units of the bank, they becomes the sole owner of the asset/property.

islamic bank of britain

Islamic bank & the client sign a Master Murabaha Finance Agreement & an agency agreement. According to the agency agreement, the customer purchases goods from the supplier on bank's behalf. The customer undertakes to buy the asset from the bank. It is a one-sided promise & undertaking. The bank pays the supplier & obtains title & physical/constructive possession of the asset. The customer signs a declaration that they has bought the goods on bank's behalf & now they is willing to buy the asset. After offer & acceptance, sale is executed & the customer pays the agreed cost to the bank.

Murabaha is a deferred payment sale transaction. Murabaha is used in working capital financing, SME financing & trade financing. The Technique flow of Murabaha is as follows:

Ijarah means to give something on rent. In Ijarah, right of use of a property is transferred to another person for a consideration. The technique flow is as follows:

Ijarah

The customer approaches the bank for obtaining an asset on lease. The customer undertakes to make periodic lease payments for the lease period. Lease agreement & agency agreement is signed. The customer as an agent to the bank buys the asset. Bank receives the title of the asset & pays the seller. The bank leases the asset & the customer starts using the asset & pays rent for each period. In the finish, the customer can purchase the asset from the bank by way of a separate purchase agreement.

islamic bank of britain