ISLAMIC BANKING TRAINING MANUAL
Module-4
Key Misconceptions
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Misconception 1:
Is Islamic Banking similar as that of Conventional banking because the results in both the
operations are same?
Response:
Deciding permissibility of transactions based on the results is not reasonable rather analyzing
the mechanism involved in achieving the results should be the accurate assessing tool to decide
permissibility of any transaction/operations. The mechanism of Islamic Banking transactions is
very different from conventional banking. We shall discuss these topics in the upcoming
chapters.
Misconception 2:
How it is possible for the Islamic banks to remain Shariah compliant while dealing with the
central bank that regulates Conventional Banks also?
Response:
In State Bank of Pakistan there is a separate Islamic Banking Division supervised by its
independent Shariah Board that monitors and regulates the whole Islamic Banking Industry.
Central Bank’s main function is to regulate the banks and monitor their activities in order to
oversee the stake of the public/depositors. Similarly, State Bank manages the reserves placed by
the Islamic Banks under the supervision of SBP’s Shariah Board and pays no interest on these
reserves.
Time Value of Money
Misconception 3:
Is there any concept of TIME VALUE of MONEY (TVM) in Islam?
Response:
In Islam, time value of money is permissible when a commodity is involved in the transaction.
Islam does not permit to charge any extra money based on the principle that a dollar today is
not worth a dollar tomorrow. However, we can sell a car/any product/asset worth 500 dollars
for 600 dollars on credit. It means that the value of the asset can increase but not the value of
currency.
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KIBOR as Bench Mark
Misconception 4:
Can Islamic Bank use KIBOR as a benchmark for calculating profit?
Response:
Utilizing KIBOR (Karachi Inter Bank Offer Rate) as a benchmark does not mean that the Islamic
Bank is earning interest. This is just a benchmark for setting targets for rate of return. For
example, we can use a one-liter container to measure alcoholic drink or water. Therefore,
calculating profit by using some thing as a benchmark does not make any transaction
permissible or impermissible in the light of Shariah.
No Concept of Banking in Islam
Misconception 5:
Some people claim that there is no concept of banking in Islam.
Response:
The use of the word “Banking” does not make any institution Halaal or Haram, rather it is the
underlying scope and nature of activities that are being conducted which makes it Halaal or
Haram. Concept of banking based on pooling of excess funds of depositors and channeling them
for investing activities is not only permissible but Islam encourages such activities. However, the
concept to lending and borrowing based on interest was prohibited in Islam.
Islamic Banking Branches of Conventional Banks
Misconception 6:
How can “Islamic Banking Branches (IBB) of conventional Banks” be Islamic while being a part
of their parent conventional bank?
Response:
“IBBs” are an integral part of their parent conventional bank, but the management ensures that
all the funds and operations are completely segregated. This is a regulatory and Shariah
requirement, to carry out Islamic Banking Business separately. While, being a part of
conventional bank, seated under the same roof does not imply that “IBB” and parent
conventional bank are same.
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Example: a person having a Halal business store and a Haram business store while operation,
funds and books of the two businesses are completely segregated. Shariah rather encourages
and validates such separate operation where operations and income from Halal store are
recorded separately.
Islamic Banking resembles Conventional Banking
Misconception 7:
“Islamic banking looks the same as conventional banking”.
Response:
The validity of a transaction does not depend on the result rather the process and activities
executed and the sequence thereof in reaching the end. If a transaction is done according to the
rules of Islamic Shariah, it is Halal even if the result of the product may look similar to
conventional banking product.
For example, a normal McDonald’s burger in USA and Pakistan may look similar, smell similar
and taste similar but the former is haram and the latter is Halal due to its compliance with the
Islamic guidelines of slaughtering animals.
The same is also true for Islamic and conventional banking operations. The contracts and
product structures used by Islamic banks are quite different and Shariah Compliant from that of
the conventional banks.
Fixed Rate of Return
Misconception 8:
Islamic Banks charge fix rate in their product such as Murabaha, Ijarah and etc.
Response:
Fixed rate of return does not make a transaction Halal or Haram, for example:
• Profit amount on sale transactions
• Rent on property
Both of the above instances where returned is fixed, and it is very much Halal. Rather, if the rent
/ Profit amount is not fixed here and uncertain upfront will turn the transaction voidable. The
fixation of profit is prohibited in investment base transaction such as Mudarabah and
Musharakah.
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Profits in Islamic Banks resembles interest
Misconception 9:
The profit given to depositors in Islamic banks looks same as in Conventional banks?
Response:
The remunerative deposits accepted by Islamic Banks are based on “Mudarabah” a kind of
partnership where one party provides capital called Rabb-ul-Maal while the other manages
those funds called the Mudharib. They share profit as per an agreed ratio announced at the time
of accepting deposit, which then interpreted in percentage to give the customers an idea of
profit they earned over their deposits.
E.g. a customer invests one hundred thousand rupees (Rs. 100,000/-) in PLS account with an
Islamic bank. At the end of the month they earned one thousand rupees (Rs. 1,000/-) they share
their profit according to the agreed profit sharing ratio (suppose 50% was agreed between
them). The customer ends up earning six hundred rupees that is six percent (6%), which might
be the same as given by the conventional bank.
Opening Interest-free account in Conventional Banks.
Misconception 10:
Can opening a current account in Conventional Bank is allowed?
Response:
In current situation, it is preferred to open an account with an Islamic Bank especially when
scholars have declared Islamic banking operation in compliance with Shariah principle. We
should avoid opening interest free current account in a conventional bank, as Banks will use
these funds deposited in such account for interest-based businesses.
Investments of Islamic Banks
Misconception 11:
Where does Islamic Banks invest the fund of depositors?
Response:
“Islamic Banks” makes investment in different Shariah compliant avenues that includes Ijarah,
sale and purchase activities like Murabaha, Musawamah, partnerships etc. Financing an Ijarah
facility earns a profit through rentals. Similarly, through a Murabaha facility will earn a profit by
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selling a commodity. These profits are then distributed between the depositors and the bank
according to an agreed profit sharing ratio.
What Distinguishes Islamic Banking
Following are the some key differences between Islamic and Conventional banking:
Sr. No. CONVENTIONAL BANKING ISLAMIC BANKING
1 Money is treated as a commodity Money is not treated as a
besides medium of exchange and commodity though it is used as
store of value. Therefore, it can be a medium of exchange and
sold at a price higher than its face store of value. Therefore, it
value and it can also be rented out. cannot be sold at a price higher
than its face value or rented out.
2 Time value is the basis for charging Profit on trade of goods or
interest on capital. charging on providing service is
the basis for earning profit.
3 Interest is charged even in case the Islamic bank operates on the
organization suffers losses by basis of profit and loss sharing.
using bank’s funds. Therefore, it is In case, the business has
not based on profit and loss suffered losses, the bank will
sharing. share these losses based on the
mode of finance used
(Mudarabah, Musharakah).
4 While disbursing cash finance, The execution of agreements for
running finance or working capital the exchange of goods &
finance, no agreement for services is a must, while
exchange of goods & services is disbursing funds under
made. Murabaha, Salam, Istisna and
any other facility contracts.
5 Conventional banks use money as Islamic banking tends to create
a commodity which leads to link with the real sectors of the
inflation. economic system by using trade
related activities. Since, the
money is linked with the real
assets therefore it contributes
directly in the economic
development.
6 Transactions are money lending Transactions are asset-
and Riba based based/backed
7 Involve in many impermissible It is socially-responsible banking
transactions like Short selling, Sale because it operates under
of Debt, Speculation, artificial Shariah restrictions
financial transactions, no sanctity
for Islamic law of contract.
8 Permit financing of Does not permit financing of
prohibited goods / prohibited goods / Industries
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Industries like alcohol,
casinos etc.
9 A matter of choice Ethics and moral values play a
major role in investment
decisions. Not a choice but a
must.
10 Is based on fixed return on Is based on profit sharing on
both Sides of the balance deposits side, and on profit on
sheet. assets side.
11 Does not involve itself in Actively participates in trade and
trade and business production.
12 Depositors get a fixed rate Profit is shared with the
regardless of the bank’s depositor, higher the bank’s
profitability, thus insulating profit, higher the depositors
them from the bank’s true income.
performance.
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