Interest free banking

1. In the name of Allah(j.j)
Chapter # 5
Interest Free Banking
By
Kokab Manzoor

2. LOGO
Contents
Definition of interest
 Economic importance of prohibition of interest
Islamic banking
 Definition and need of Islamic banking
 Supremacy of Islamic banking
 Bill of exchange & Interest free loans
 Comparison of conventional & Islamic banking
Insurance
 Definition, Evolution, importance and Islamic
Concept of insurance

3. LOGO
Definition of Interest
Interest is the price of capital. The Holy Quran
uses the word Riba to denote interest which
means increase, growth, addition, raise, excess.
 Allah deprives interest of all blessing and develops
charity [Al-Baqara; 276]

4. LOGO
Why did Islam forbids
Interest..???
CAPITALIST ECONOMY
Factors Compensation
LAND RENT
LABOR WAGES
CAPITAL INTEREST
ENT PROFIT
ISLAMIC ECO SYSTEM
Factors Compensation
LAND RENT
LABOR WAGES
RISK CAPITAL PROFIT
In Capitalist Economy there are four factors of Production
while Islamic Economic system recognizes only three
Factors of Production.

5. LOGO
Economic Importance of
Prohibition on Interest
Investment MEC Interest-Rate
100 mn 24 % 18%
200 mn 22 % 18%
300 mn 20 % 18%
400 mn 18 % 18%
1 Interest and investment
• Capital investment depends on the one hand on
the rate of interest and on other hand on MEC.
• The process of investment in a country will
continue as long as MEC is higher or equivalent
to rate of interest, and vice versa…

6. LOGO
Cont`d…..
2 Interest and Price
3 Interest and Distribution of Wealth
4 Interest and Trade Cycle
5 Interest and Allocation of Resources
6 Interest and business
7 Interest and Efficiency
8 Interest and Economic Stability
9 Interest and International Loans

7. LOGO
BANK
Bank is an institution which deals in credit
Functions of banks
 Accepting deposits
 Advancing loans
 Providing agency services
 Money transfer
 Safe deposit lockers
 Investment
 Credit creation

8. LOGO
Need for Interest Free Banking
 Modern banking system gives rise to
injustice, oppression, waste of resources
and inequitable distribution of resources
among nations.
And as modern banking system is based
on Riba (interest) and Islam forbids
interest. Meanwhile the utility of Banks is
acknowledged, so it is necessary to reform
the banking system according to the
principles of Islam.

9. LOGO
What is Islamic Banking ??
Since interest is forbidden by Islam, Shirakah
(partnership) and Modarbah will be the only
alternative basis of banking in Islamic economy.
A bank will be established by two or more
individual making investments according to a
fixed ratio
 Islamic banking has been defined as banking
governed by the principles laid down by Islamic
Sharia’h

10. LOGO
MECHANISM OF ISLAMIC
BANKING
Under Islamic scheme of banking there may
two types of depositors.
1 The one who deposit surplus amount and
can withdraw at anytime, bank will charge
Zakat or service charges for safeguarding.
2 They can not withdraw their money without
notice as their amount will be invested in
short term projects. The depositors will share
in profit and loss.

11. LOGO
Business of the Bank
The business of the Bank may assume
three forms,
1 Services on which a charge is made
2 Investment on the basis of Shirakah
(partnership) or Modarbah basis
3 Free services

12. LOGO
1 Services on which a
charge is made
Like modern banks, the Islamic banks will
also receive fee, commission or fixed
charges on various services like;
a) Facility of lockers
b) Transfer of Money
c) Receiving and Forwarding of trade Goods
d) Services as financial and legal consultants to
business corporations

13. LOGO
2 Investment on the basis of
Shirakah or Modarbah basis
The interest free banks will enter into Shirakah
or Modarbah transaction with businessmen.
Shirakah
A contract between partners on both capital
and profit.
Modarbah
A contract between partners in which one
provides capital and other provides services.
 Note these two will be discussed in detail in next
chapter

14. LOGO
Issue of Loans in interest free
Banking system
1. The bank will issue loans without any
charge to businessmen for short period.
2. Such loans will be issued by the bank out
of “Loan Account”
3. The debtor will provide guarantee
4. Bank have right to invest the available sum
in “Loan Account” in profitable venture.
5. Banks shall also be entitled to take charge
free loans from Central Bank.

15. LOGO
Bill of exchange & interest-free
Loans
Discounting Bills of Exchange would not
be permissible; however following
procedures may be adopted
 Instead of bill of Exchange the businessmen
should take loans from Banks on Modaraba
basis,
 Bank will advance charge free loans
 The bank will make no deductions, and will
recover the full amount on the date of the
maturity of the bill of exchange.

16. LOGO
Process of Credit Creation in
Islamic banking
Bank will keep 10% as reserve of Loan Account
for meeting daily needs
Loan advanced, will be again deposited in bank
Bank will hold large amount of deposits and rest
will be invested in Modarbah
That amount will be deposited in various other
banks, hence bank receives back a large part of
the money it lent out or invested.
Hence the process of credit creation is similar to
conventional banking but the technique is
different

17. LOGO
COMPARISON
Conventional banking
 Borrows funds from the
depositors paying interest
on the liability side of its
balance sheet.
 Lends the funds to the
borrowers, charging
interest on the asset side.
Islamic Banking
 Partnership (Mudarabah)
or profit and loss sharing
arrangement between the
bank and the depositors
 Profit and loss sharing
(Musharaka) or trade and
leasing based financing
arrangement between the
bank and its clients users
of funds)

18. LOGO
Conventional banking
 Between the depositors
and the bank, there is an
iron wall.
 The interest or the return
is predetermined or
fixed in advance
Islamic Banking
 Islamic bank entitles the
depositors
--to be informed of what the
bank does with their money
--where their money would
be invested
 The profit or the return is
based on the actual
investment outcome.
COMPARISON

19. LOGO
COMPARISON
Conventional banking
Money earning money
without real sector
business: Transactions
are financial asset
based
Islamic Banking
Transactions are real
asset based as per
defined principles of
trading or leasing

20. LOGO
SUPERIORITY OF ISLAMIC
CONCEPTION OF BANKING
Conventional banking
 Loan on interest-- chance of unhealthy
investment—leads to depression and
ultimately unemployment– also acts criminally
if borrower fails to repay.
Islamic banking
 Interest free loans– banks interested in
investment rather than loan--so healthy
investment takes place– reduces
unemployment rate--less chance of
depression-even if, can easily be countered.

21. LOGO
Summary & Conclusion
1. Riba, usury, Interest are prohibited.
2. Saving is the function of investment not the interest.
3. Islamic banking is based on principles of
partnership.
4. Short term and long term financing can be made
through system of guarantee.
5. Strong relationship of banks with depositors and
entrepreneurs.
6. Islamic banks can contribute better to economic
development by performing extra banking activities.

22. LOGO
Islam and Insurance

23. LOGO
Definition of Insurance
Definition
 “a contract whereby one person, called the
“insurer” undertakes, in return for the agreed
consideration, called the “premium”, to pay to
another person, called the “assured” a sum of
money, on the happening of a specified event.
 This specified event must have some element
of uncertainty about it.

24. LOGO
Importance of insurance
Risk and uncertainty are part of daily life of
human being
Risk is of two types
1 (Risk of loss) In any economic activity a
person may gain profit or suffer loss
2 Breakage of crockery, glassware etc, or
accidents, injuries, Hazards, sinking of ships
etc…

25. LOGO
Importance of insurance
In business the second kind of risk is the
greatest target of insurance.
It gives sense of security to businessmen
Improves efficiency
Raise morale to face risk

26. LOGO
Evolution of Insurance
Started to meet risk of traders whose
ships were often wrecked by storms
Muslims maritime traders during the
Islamic rule in Spain were the pioneers.
Arab traders launched a system of
insurance on a Shirakah basis.

27. LOGO
Takaful
Islamic concept of insurance
Takaful is an Arabic word that means
"guaranteeing each other".
It is a system of Islamic insurance based on
the principle that “the risk will be shared
collectively by the group Voluntarily”.
This is a pact among a participants who
agree to guarantee among themselves
against loss or damage to any of them.

28. LOGO
Basic Principle behind Takaful
1.The principle of “fortunate many helping the
unfortunate few" is a concept recognized by
Islam.
2.The Quran states in Surah Al-Maidah verse # 2:
"Help ye one another in righteousness and piety, but
help ye not one another in sin and rancor".

29. LOGO
Operation of Takaful Fund
The contribution collected by company will be
further invested on the principle of Al –Modarbah,
through which the element of interest (riba) will be
replaced.
All premium holders will participate in pofit and loss.
Profit will be shared on agreed ratio.