Islamic Finance

Mechanism of financing in Islamic banking

The commercial or conventional banks conduct loans and advances operations to their customers in exchange for specific interest in advance. However, the Islamic banks use the money through multiple and legal funding formulas which fit to all activities, whether commercial, industrial, agricultural, real estate, vocational or artistic. The financing is consider one of the most important activities in Islamic banks, where their revenues represent the most important source of profits. There are many Islamic mechanism of financing, including: financing by Murabaha, Musharaka, Mudarabah, Estisnaa, Sallam, Ijara and Tawarruq.

Buying household furniture by Murabha:

Me as a customer I will request the Islamic bank to buy certain commodities which is home furniture and provide a price offer to the Islamic bank that includes the price of the furniture and its specifications to avoid Gharrar or ignorance. Then, I sign the Murabaha contract to promise to purchase with a deferred price. After that, the Islamic bank will buy the same commodities from the supplier (Musawama contract) based on specified conditions and specifications by me. The bank will be the owner of the commodities then sell them to me by new contract called Murabaha contract after I ensure compliance with specifications, and the Murabaha contract should include the agreement on the purchase price, profit and the installment duration.

When comparing Murabaha contract in Islamic bank and an interest-based loan in the conventional bank, it shows that the Murabaha is an alternative to usurious loan, a customer that need a commodity may request the conventional bank and get a loan with interest. The differences between them that the basis of contracting in Murabaha is the commodity and the increasing is on its price, but in the interest-based loan the basis is the money, So, it becomes usurious transaction by increasing the loan, and it will rise with time. Opposite to Murabaha the loan is fixed.

Starting new business (beauty center) by Mudarbah:

Mudarabah contract is a kind of collaboration between two partners where one partner provides money (Islamic Bank, rabb-ul-mal ) to another (Me, mudarib) for investing it in a business enterprise ( Establish a Beauty Center).

In my beauty center, I will need a financing to create a budget, get a business license, find a place to set up and work, hire qualified employees, buy equipment and assets. Profits generated will be shared between us according to a pre-agreed ratio.

The Bank and I will agree on the capital and ratio of profits and specify a sufficient period for me to return the capital to the bank. After that, I can start my business.

But in the conventional bank, the bank will give a loan as capital and specify interest ratio which is prohibited in the Principles of Islamic finance and considered as riba.

Buying an apartment by Ijara:

Me as a customer I will request the Islamic bank to buy the apartment and promise to lease. After that, the Islamic bank will buy the apartment from the owner of the building (sale contract), The bank will be the lessor of the apartment then sell it to me as the lessee by new contract called lease contract and the contract should include the agreement on the fixed rent's price and rental payment duration.

In a conventional lease involves penalties will be assumed for late payment of rental, which are stated as a percentage of the total. which consider as an interest payment, it is prohibited under Shariah.