Objectives, Philosophy and Principles of Islamic Banking by Sudin Haron, W. Nursofiza, (2009). Islamic Finance and Banking System : Philosophies, Principles & Practices. Selangor, Malaysia. McGraw-Hill (Malaysia) Sdn. Bhd.

1. Chapter 2
Objectives, Philosophy and
Principles of Islamic Banking
FAB 1233 – Islamic Banking
Made by:
Nor Izzuddin Bin Norrahman, BBA.
Lecturer of Management,
Banking & Islamic Finance
Astin College, Puchong

2. Reference:
• Sudin Haron, W. Nursofiza, (2009). Islamic
Finance and Banking System :
Philosophies, Principles & Practices.
Selangor, Malaysia. McGraw-Hill (Malaysia)
Sdn. Bhd.

3. Contents…
• Introduction
• Objectives of Establishment and Business
Philosophy of Islamic Banks
• Factors that influence the formation of the
philosophy of Islamic Banks
• Sources of Islamic Banking Philosophy
• Operational Principles
• Priorities in the use of Syariah Principles

4. Introduction
• The process of “Islamize” the economic
system raised several theoretical and
conceptual considerations in order to
implement it in the new economic system.
• At the time, only three system existed –
socialist, socio-capitalist and capitalist system.
• At that time also, there were no appropriate
model encouraged the Muslim country to
start the Islamization from the Banking Sector.

5. Continue…
• The Islamization in the economy involved one
principal point : the ELIMINATION of
INTEREST in all deposits and financing
transactions.
• However, some people may questioned, is it
appropriate to call it an Islamic bank when the
transaction is similar to the conventional bank
except for the matter of interest?

6. Continue…
• The objectives of the Islamic Banks
establishment is to offer banking needs to
Muslims
• And, these Islamic Banks run alongside
conventional bank.
• Thus, there are some similarities showed in
the transactions.

7. Conventional Banks Transaction
Conventional Banks
Primary Function
Savings Deposit
Savings Account
Current Account
Fixed Deposit Account
Negotiable savings certificate
Loans
Individuals, Businesses, Public
Sector, Other Group
Secondary Function
Facilities
Letters of Credit, Letters of
guarantee, others
Service
Money order
transactions, money
exchange, advisory services

8. Islamic Banks Transaction
Islamic Banks
Primary Function
Savings Deposit
Savings Account
Current Account
Fixed Deposit Account
Negotiable savings certificate
Loans
Individuals, Businesses, Public
Sector, Other Group
Secondary Function
Facilities
Letters of Credit, Letters of
guarantee, others
Service
Money order
transactions, money
exchange, advisory services
FREE FROM RIBA /
ACCORDING TO SHARIAH

9. Objectives of establishment & Business
Philosophy of Islamic Banks (IB)
• In principle, business institutions aim for
PROFIT MAXIMIZATION
• More-over for the Private Companies
• Indicators:
– Large Profit – Organization is running effectively
– Shareholders – Shareholders would want high
return from their shares.
• Is Islamic banks the same?

10. Islamic Banks objectives…
• Founded on 2 key factors:
– Religion
• The organization must internalize the teachings Islam.
• So, Islamic banks would have to CONFORM and COMPLY
with Islamic principles.
• It will involve moral elements by virtue of the factor of Iman
(faith and believe) in the business operations.
– Profit
• If the moral factors alone is given importance, there is
possibility that the bank would experience losses and forced
to ceased operations.
• And this would deny the objectives of Islamic banks that is to
fulfill the needs of Muslim.
• So, Islamic banks also given importance to the business
dimension.

11. Continue…
• Khan (1983) stated that:
• The objectives of Islamic Banks is to DEVELOP, FOSTER and
PROMOTE the use of ISLAMIC PRINCIPLES, LAWS, and
traditions in all BANKING TRANSACTIONS, financial, business
and other related areas.
• Another objectives is to promote the
establishment of investment companies or other
business enterprises which according to Shariah
laws.
• Different Islamic banks have different goals and
objectives, but it is always includes the moral and
business dimension.

12. Factors that influence the formation of the
philosophy of Islamic Banks
Internal
• Factors from
the
organization
itself
External
• Factors
beyond the
control of
organization
Islamic
Banks

13. Continue…
• The philosophy of the Islamic banks will be
influenced by external and internal factors.
• Internal factors play important role in the initial
stage of the bank’s establishment.
• Example:
– Investor use their money to set up the bank
– As the result, the investor would want high returns :
resulting profit maximization.
– In reality, the owner and the manager consist of
different types of group.
– This will influenced the philosophy of the Islamic bank
: the owner vs. the management.

14. Continue…
• The management would be influenced by
three conceptions:
– Demand of high returns from the shareholders.
– Rewards received by the management.
– The depositors demand.
• All the conception would influence the Islamic
bank to look within the business dimension
only and disregard the moral dimension.

15. Class of Islamic Banking Institution
• 1st Class
– A financial institution merely offers services which is not
prohibited in Islam
• 2nd Class
– The financial institution that claimed that they are Islamic
Financial institution, but the products and services that
they offer is similar to conventional bank.
• 3rd Class
– The best in category
– Offer Islamic Financial Services and all of the aspect is
based on Islamic business principles.
– View the profit is important, but it must be balanced with
the requirement of social justice.

16. IB vs. CB
IB CB
Must comply fully with the
requirements of akidah by avoiding
prohibited elements.
Does not comply with akidah and
contain prohibited elements as long as
it is profitable.
IB must be caring and more
understanding to their customer.
Did not include moral factors in their
operations.
Have goals on socio-economic
development and poverty eradication,
not only profit.
Only focus on profit.
The operations is according to shariah. The operation is freely done.
Charges on customers in accordance
with the actual cost incurred.
Could charge their customer with cost
that incurred in the future.

17. Sources of Islamic Banking Philosophy
Primary
Sources
• Al-Quran
• As-Sunnah
Secondary
Sources
• Qiyas
• Ijam’
• Others
Islamic
Banking

18. Operational Principles of Islamic Banks
Operational
Principles
Musyarakah
Mudharabah
Murabahah
Ijarah
Qard Hassan
Wadiah
Rahn
Other
Principles

19. Continue…
Other
Principles
Bai Bithaman
Ajil
Bai al-Dayn
Bai al-inah
Bai istijar
Bai salam
Hiwalah
Istisna
Jo’alah
Musawamah
Sarf
Ujr
Urbun
Wakalah
Tawarruq

20. Musyarakah
• Means partnership in English. (Profit and loss sharing)
• Two categories:
– Syirkat al-mulk
• Involves joint ownership of certain properties and it does not involve
any joint venture to DEVELOP the properties.
– Syirkat al-’aqd
• The concept of joint exploitation of capital and the joint participation
in profits and losses (Saleh, 1986).
• There are three methods in establishing Syirkat al-’aqd:
– Syirkat mal
• (Involve money in create partnership)
– Syirkat a’mal
• (Depends on the expertise, experience and skills from the partnership)
– Syirkat Wujuh
• (Partnership based on asset of the credit or investment made in the
company)

21. Musyarakah (Continue…)
• Partnership:
– Unlimited (Mufawada)
– Equal (Syirkat al-inan)
• In the context of Islamic banking, the musyarakah
principle which is relevance is inan syirkat mal or
limited financial investment partnership.
• In simple terms, musyarakah means a joint-
venture agreement between two parties to
engage a specific business activity to make profit.

22. Mudharabah
• Translation: profit sharing
• Concept: Those who have money (investor)
would assign their money to another party
(entrepreneur) to carry out a business and the
profit will be split according to the ratio agreed by
both party.
• Two type:
– Mudharabah muqaiyadah
• Certain rules have been set to the entrepreneur in order to
carry out the business.
– Mudharabah Mutlaqah
• No specific rules have been set to the entrepreneur in order
to carry out the business.

23. Murabahah
• Known as cost-plus sale.
• Refers to the sale of goods at a price of the
cost plus a profit margin agreed upon by both
parties concerned.
• Example:
– Cost: $1
– Profit margin: 50%
– Cost + profit margin: $1 + ($1 x 50%)
: $ 1.50

24. Ijarah
• Term: Leasing
• Means contract to lease or rent or hire.
• The person that lease a property is only paying
for the benefit of the property, not for it’s
ownership.

25. Qard Hassan
• Term: Benevolent loan
• A loan which the borrower is obligate to repay
the lender the exact principal sum borrowed.
• Example:
– Ali borrowed RM500 to Hassan in a qard Hassan
contract.
– So, Ali is only obligate to pay not more, not less
then RM500.

26. Wadiah
• Term: Safekeeping
• An agreement between the owner of assets with
another party (the keeper).
• The owner of the asset give the asset to the keeper’s
custody.
• If the assets are damage / loss (not in the negligence of
the keeper), the loss will not bear by the keeper.
• Al-Wadiah yad dhamanah (Guaranteed Custody)
– The keeper give guarantee to safe keep the asst. The
keeper could use the asset and in case of damage to the
asset, the keeper obligate to take the responsibility.

27. Rahn
• Term: pledge / pawn
• It is a contract of security.
• The creditor secures a loan trough a pledge of personal
property. The ownership of the property is remain with
the borrower but the possession is now belong to the
lender.
• Certain fees will be charged if the borrower could not
pay the debt in time due to the keeper have to safe
keep it.
• In case of the borrower could not pay the debt, the
property will be sold to cover the debt and the
management expenses. The remaining then will be
given back to the borrower.

28. Bai Bithaman Ajil
• Term: Deferred payment sale
• The payment is made in future time. By lump sum
or by deferred payment.
• Example:
– Ali uses murabahah contract to buy a car. The cost is $
1000 and the profit margin is 20%. So, the selling car
price is $ 1200. Ali enters another contract which is to
pay the car in deferred payment by monthly payment
for 4 years. So, Ali will pay:
• $ 1200 / (4 year X 12 Month)
• $ 1200 / 48 Month
• $25 / month

29. Bay al-dayn
• Term: Debt trading
• Financing is made based on sale and purchase
of trade documents.

30. Bai al-inah
• Term: Sells & buys back contract
• Involving 2 separate contract.
– 1st Contract:
• Bank sell a property to Ali $ 1000 and Ali pay the bank with a
differed payment method.
– 2nd Contract:
• Then, Ali sell back the property to the bank with more
cheaper price, $ 500.
• The bank will pay in lump sum.
• That is the example of a bai-al inah contract. The
contract is used in the personnel financing tools.
• Some mazhab do not approve this contract.

31. Bai istijar
• The sale and purchase contract whereby an
agreement is made between two parties.
• Under this contract, the buyer agrees to buy
on a continuous basis, and there will be no
more bargaining afterwards.

32. Bai Salam
• Contact of sales and purchases.
• The payment is made in present but the asset
will be delivered at a later date.

33. Hiwalah
• Transfer of funds / debts.
• Charges will be applied by the bank in
performing the transaction.

34. Istisna
• A sale and purchase contract.
• Under this contract, the buyer is agree to buy
non-existent goods which are to be
manufactured later by specification.
• The buyer can pay up-front the contract or
when the goods is delivered.

35. Jo’alah
• Refers to service charges.
• Practiced in Iran.
• The service will be charged for some amount
of money.

36. Musawamah
• Similar to mudharabah, except that no
reference is made to the buyer as to the cost
price.
• There is no need to the seller to disclose the
cost price.

37. Sarf
• Contract of sale and purchase of foreign
currencies.
• Mazhab do not allow if it involve
forward, specified future date or fixed
purchase date.

38. Ujr
• Refers to fees and commissions charged for
services rendered.

39. Urbun
• Means: to pay or to receive in advance.
• The buyers buy commodity and pay deposit
for it.
• The deposit may be used by the bank to carry
out certain responsibilities on behalf of its
customer.

40. Wakalah
• Means: Representative
• A person is appointed to do something.

41. Tawarruq
• Differ with bai al-inah.
• Involves third party.

42. Priorities in the use of Syariah
Principles
• In the consensus among Muslim
scholars, various Islamic principles used by the
Islamic Bank can be divide into two category:
– Principles which are advocates
• Strongly Islamic
• Principles are those that conform to Islamic objectives
in form and substance.
– Principles which are not advocates
• Weakly Islamic
• Refer to practices which conform to the Islamic norms
in form but not in substance.

43. Continue…
• Strongly Islamic principles – Those principles
which permit risk-return sharing between
providers and users of funds which are:
– Musyarakah
– Mudharabah
• However, most scholars recommend that the
remaining principles be used in cases where
risk-return sharing cannot be implemented.