Interest Free Banking is a kind of banking system which is derived from Islamic economic system. The operation of Islamic banks is designed in such a way that interest is excluded for Muslim from paying or receiving. It does not mean that there will be no income generation operation or for those businesses having surplus money will not be able to invest their money. All of these business forms are encourage making funds available through Islamic banks for their project or making investment of their surplus funds. There are a lot of financial tools introduced by the Islamic financial bodies to fulfill the needs of these businesses. For a clear understanding, they deal with equity financing rather thanusing a debt financing. For the replacement of interest rates Islamic banks use Profit &Loss sharing basis against predetermined rates of interest.The purpose of Islamic Banking and Finance system is to have all type businesses according to the principals of sharia.
Islamic business system deals with equity financing rather thanusing a debt financing. In addition, as a replacement of fixed interest rates or variable interest rates on the savings account, investment and financial securities these interest free banks give a small percentage return on deposits on an annual basis using profit &loss basis.
Interest free banking system is very essential for Islamic countries and specially for the development of Islamic banks. Nonetheless, individually all the banks differ from the services and benefits. These differences occur due to the country rules, needs of the people and the bank’s experiences and objectives.
The concept of Islamic interest free banking is becoming widely popular also in the Non-Islamic countries too. The interest free banking helps a person become debt free which is the most wonderful feature of Islamic banks. The interest free banks work with the rule that the lender must have a share from the profits or the losses that occur to the borrower. Thus the sharing of the profits as well as the losses is the obligatory in Islamic Banking System. The lender and the borrower are like partners and that plays a major role in betterment and welfare of society. In turn it also to helps remove the difference and discrimination between the rich and the poor. The interest banking system on the other hand collects huge amounts of interest from the borrower regardless of the success or the failure of the operation of business. It places a huge amount of risk on anybody that is borrowing the money and is cruel according to Islam.
Objections, Reservations
According to the west Islamic banking system is not a bank in real since and it is a system through which Trade is taking place or a joint venture can be created.
Other people argue that Islamic banks operate like other conventional banks and there is no difference between them.
Another objection on Islamic bank is that it used kibor as a standard like other conventional bank and their no difference between interest free banking and conventional banking system.
Many people also says that even if interest is prohibited in Islam, interest free banking is not practicable in the modern world as an economic system without interest will be difficult to operate in the modern world.
Another reservation on interest free banking is that it will not be able to effective allocation of resources.Ahmad, H. (2006)
Objections, Reservations and their evaluations:
It is now proposed to discuss and analyze these objections and reservations.
The interest-free banking system will not be able to bring an optimum allocation of resources. It is argued that since funds will be available at zero rate of interest, the demand for money will increase and without interest rates, there will be no tool for balancing demand and supply of money.
This argument is based on a gross misconception. It is important to clear that interest-free banking does not mean that funds will be available free of cost to the investor for their business requirements. Islamic system of interest-free banking means that finances will be available on profit and loss sharing basis as against predetermined rates of interest. The rates of profit depending upon the operational results, will, therefore, replace interest rates in allocation of resources and will also provide a system for balancing the demand and supply of money.
The availability of funds for a project will largely depend, with in the Islamic framework, on the projected rate of profit i.e. greater the projected rate of profit or efficiency, the greater may be the supply of funds to that project. If the actual profit is constantly lower than the projected profit, the investor likely to face difficulty in securing funds for his project in future. The system of profit sharing is therefore likely to be more instrumental in creating financial discipline, higher efficiency and would lead to a more careful and realistic feasibility and evaluation of projects as also for finance monitoring. This would result in not only higher rates of profit but would also provide a better and more efficient mechanism for allocation of resources as compared to interest-based system. in any case, there is no evidence for support of interest rate as an effective tool for financing or for allocation of resources.
Islamic system discourages keeping the funds idle and in the absence of interest banking system those funds can be used for production, trade and business which will improve the financial condition of individual’s, institutions and government as well which will beneficial for the society as whole.(IRTI, 2007)
What is Islamic Banking?
An Islamic bank is a financial and social institution which identifies itself with three principle of shariah as laid down by the HOLY QURAN AND SUNNAH as regards its operation, practices and operation.
Philosophy and Development
We need Islamic banking in order to have free interest banking system or alternate to interest based banking system. its objective is to make positive contribution to the fulfillment of social andeconamic objective of the society in all spheres including trade, agriculture, industry, employment, ecomamic condition, environment , inflation, science and technology, benevolent sector, with special focus on human factor.
We want to have business and investment activities as per sharia principle, so to ensure such activities we need financial market, financial institution, financial intermediaries and financial instrument according to Islamic rules.
An Islamic bank does not lend money except the interest free loan which is termed as Qard-e-Hasana which is for marriage and education. Basically Islamic bank is partner in trade, industry, and agriculture for production and development finances. Actually Islamic banks employees zero rate of interest not zero rate of return as Islamic banks do not deal in money but deal with money.Islamic banks usually have its own target for the determination of profit which is not fixed and mostly variable depending upon the operation of the project in which the investment has taken place, although in certain transaction the profit is predetermined for permissible transaction does not make the transaction haram.
NonFund Based Transaction
Islamic banks besides their range of financing and lending operations of funds, also offer a full variety of fee-paid retail services that do not involve interest payments, including checking accounts, spot foreign exchange transactions, fund transfers, letters of credit, safe-deposit boxes, securities safekeeping investment management and advice, and other normal services of modern banking. Islamic banking because of its value-orientated strategy enables it to draw finances from both Muslims and non-Muslims. Chaudhry, S. (2006)
Investment Activities
MUDARABAH
MUSHARAKAH
MURABAHAH
IJARAH (Leasing)
LOAN ON SERVICE CHARGE
INTEREST FREE LOANS etc.
Social Activities
Qard e Hasana
Islamic Banks Provides Qard e hasana to the poor people for non-commercial activities like marriage , education etc or for small business requirements. In such cases only the principal amount is payable.
Zakat
Collection and deduction of zakat from shareholder , investor and depositors as also the administration of zakat fund and distribution from this fund to the poor and needy as per the guidelines provided by the holy Qur’an.
Financing under profit and loss sharing system:
The bulk of financing under the Islamic system is equity oriented. In this mode of financing, the risks and losses are shared by the financer along with the entrepreneur in the ratio of their respective capitals. The profits are, however, shared in an agreed ratio.
Equity financing may be carried out in various forms including participation in equity of joint stock companies or shares in partnership or in the form of temporary equity on profit and loss sharing basis for the working capital requirements for a specified period. As the financing under this mode is based on profit and loss sharing.
Islamic banks pay more attention to the profitability of the project and not merely on collaterals. As is obvious, this mode of financing has some inherent risks and can successfully operate in an honest and just society. If unethical practices are followed, duplicate books of accounts are maintained, and true profits are not declared, this mode of financing is likely to suffer serious setbacks. It is for this reason that Islamic banks have been shy in adopting this mode of financing on a large scale.Ahmad, H. (2006)
Potential of Islamic banks:
The Potential of Islamic banks has tremendous and it has outstandinggrowth over its short spam of life.
Islamic banks starts its operation from mitghamir in egypt in 1963,and the was mitghamir saving banks and name was changed in 1971 to nasir social banks.
In 1975 there are 5 Islamic banks.
In 1980 there are 25 Islamic banks,
In 1989 there are 67 Islamic banks,
In 1994 there are 133 Islamic banks,
In 2000 their more than 200 Islamic banks,
In 2009 there are round about 250 Islamic banks.
Upto 2002 the Islamic banks is practicing its operations in 45 countries, 30 are muslim countries and 15 are non-muslim countries.
In the muslim world islamic banking is working in Pakistan, Iran, Egypt, Kuwait, malysia,sudan and in UAEetc.
Many Muslim countries are presently involved in interest-free banking system and it is visualized that by the year 2050, a significant number of Islamic countries would switch over or world be in the process of switching over to interest-free banking system.(Adnan wazir-2009)
Conclusion
Islamic banking system can be used as instrument against examining the challenges facing the development in national financial sector development policies. Application of Islamic banking in the financial sector development strategies with a view to making financial services available to the people so that they can use it for the betterment of society would be a great asset. Islamic banks have the ability and capacity to facilitate in policies regarding the financial infrastructure and financial institution development and can be used with a view to making financial services accessible and affordable to the whole society ..
