Introduction
Islamic banking is banking in accordance with the Islamic law. Islamic banking is one of the world’s fastest growing economic sectors. In an Islamic environment, the approach to financial operations such as the law of contracts, nature of property, interest rates and business transactions is quite different from the rest of the world. Islam, both in non-Islamic and Islamic countries like Iran handles financial matters in a specific way according to Islamic law. Therefore, financial institutions operating in an Islamic environment face certain challenges. Islamic banking is currently practiced in many countries and major cities around the world. To mention a few, they include Turkey, Pakistan, Jordan, Malaysia and London. This case study focuses on the operational model of Islamic banking, which includes the challenges met in the practice, the basic principles and concepts involved in Islamic banking, the way Islamic financial institutions operate within different social, legal and religious surroundings. The role of Islamic banking in development and the relationships with other banks is also covered. This information may be useful to economists, financial advisors brokers and students (Kettell, 2011).
Main body
Dubai Islamic Bank DIB, located in Dubai, is the largest bank that incorporates the principles of Sharia law in its practices. Established in 1975, it is the world’s first Islamic bank, which is also the largest bank in Dubai. DIB operates in major cities in Pakistan, Turkey, and Jordan. It provides corporate banking, treasury products and merchant banking to corporate entities. DIB has been successful in combining traditional Islamic practices with technology into a perfect mix. To match its rapid expansion, DIB has incorporated state-of-the –art facilities such as being first to offer an Islamic Visa Debit Card, offer internet and priority banking. Being the pioneer in Islamic banking, Dubai Islamic Bank offers a wide variety of products and services, which are Sharia compliant. Its clientele ranges from private, small and medium companies through corporates to governments. It offers financial solutions with respect to project finance, commodity finance, investment banking, corporate finance, capital and debt finace.DIB has been forefront in boosting the economy of Pakistan by encouraging foreign investment in Pakistan. It has achieved this by the establishment of DIB Pakistan Limited, a fully owned subsidiary of DIB. Some of the services offered include: online banking, phone banking, mobile and SMS banking, express banking and investor relations. Some of the financial products include: Auto Financing, Home Financing and Depository products. DIB prides itself to offer its clients the dominant priority (Al-Omar & Abdel-Haq, 1996)
Currently, Islamic banks operate in 49 countries across the five continents, from Africa through Europe and Asia. Based on the Islamic economic system, Islamic banking is not restricted to Muslims only; it is of the welfare of all humanity. The significant modes of financing in Islamic models include: Musharakah, Mudarabahh, Murabaha, and Salam. Istisna, Ijarah, Hiba, Musawamah, Bai Muajjal and Wadiah.According to the Islamic rules and regulations “Fiqh-al-Muamalat”, the basic principle is the sharing of profit and loss known as Murabahah. In mortgage transactions, Islamic banks buy the property from the seller and re-sell it, at a profit, to the borrower/buyer who has the option of paying in installments. The property is registered with the name of the borrower/buyer at the beginning of the transaction and the bank does not charge any additional penalties for defaulting or late payment. Loans for vehicles are also transacted in the same manner. Musharaka al-Mutanaqisa is a term applied in Islamic banking; it is commonly applied to home loans where the bank lends at a floating rate in the form of rental. The parties, the bank and the client, form a partnership which purchases the item which is then rent out to the client. The partners distribute the earnings according to equity ratio. The client (borrower) then buys off the bank’s share in installments until he owns a 100% of the item.
If there is any defaultment, the item is sold and the earnings distributed among the parties based on share equity. Musharaka, which means joint venture, involves the issuing of floating rate interest loans. This allows the bank to gain profits based on the company’s annual profit. According to Islamic principles the borrower should not face the cost and risk of failure wholly; it should be shared between the lender and the borrower hence ensuring balanced distribution of income. Murabaha means sale on mutually agreed profit; the client requests the bank to purchase some property in return for compensation in form of profit under time value of money. Salam applies to sale contracts in which goods to be delivered at a future date are paid in advance. Istina deals with contracts under the manufacturing field, which allows future payments and deliveries. Ijarah implies lease, wage or rent; the bank allows the client to use some property for an agreed period at a certain price. Musawama allows for bargaining of prices between the buyer and the seller without any reference to the cost of the commodity. Bai Muajjal refers to sale on credit; the bank gains profit margin on the client’s purchase price while the client pays for the commodity in installments or lump sum (Wohlers-Scharf, 193). Hiba is applied by Islamic banks where banks pay “gifts’ to their clients based on their savings account balances as a representative of the profit earned by the use of such savings. Wadiah refers to safekeeping; the bank accepts deposit from their customers for safekeeping (Archer & Ahmed, 2002)
In 2010, Dubai Islamic Bank launched a new revolutionary product known as Al Islam Salam Finance. Based on a sale contract, Salam finance provides for the purchase of a commodity upfront by the bank on condition that at a future date, the bank will receive a certain portion of the item. The bank will generate profits by reselling the sugar at higher prices. The targeted market is in sugar trade, this is because sugar presents less volatility. After discussions and evaluations the Dubai Islamic Bank decided that sugar was the best commodity price volatility wise. Leading these discussions was Adnan Chilwan, chief of retail and business at Dubai Islamic Bank. He assured investors that market for the sugar was available when the bank takes delivery. Salam contracts allows price fixing, the buyer and seller agree on the price now to avoid future price fluctuations. Salam contract can be linked to futures trading, with the only difference being under Salam finance, only delivery of goods can be deffered while in futures payments and commodities can be deffered. The head of DIB Sharia supervisory board said that the principles of Salam finance were in accordance with sharia law (Venardos, 2011).
Conclusion
The growth of Islamic banking is unrivaled, especially in the UAE with special reference to Dubai Islamic Bank. The Islamic banking system plays a major part in the banking industry and should not be ignored or left behind. Therefore, the study of Islamic banking will benefit the researcher and also offer important information for many classes of bank customers.
References
Al-Omar, F. & Abdel-Haq, M. (1996). Islamic banking: theory, practice, and challenges. Zed Books.
Archer, S. & Ahmed Abdel Karim, R. (2002). Islamic finance: innovation and growth. Euromoney Books and AAOIFI.
Kettell, B. (2011). Introduction to Islamic Banking and Finance: Wiley finance series. John Wiley & Sons.
Venardos, M. (2011). Islamic Banking and Finance in South-East Asia: Its Development and Future. World Scientific.
Wohlers-Scharf, T. (1983). Arab and Islamic Banks: New Business Partners for Developing Countries. OECD Publishing.