It is prohibited to deal in interest. "Those who devour usury will not stand....Allah has permitted trade and forbidden usury.... Allah will deprive usury of all blessing, but will give increase for deeds of charity..." (Qur'an 2:275-6). "O you who believe! Devour not usury, doubled and multiplied. But fear Allah, that you may really prosper" (Qur'an 3:130) This prohibition is for all interest-based transactions, whether giving or receiving, whether dealing with Muslims or non-Muslims. It is reported that the Prophet Muhammad (peace be upon him) cursed those who pay interest, those who receive it, those who write a contract based on it, and those who witness such a contract.
It is forbidden to gain property or wealth by fraud, deceit, theft, or other falsehoods. "...Give just measure and weight, and do not withhold from people the things that are their due. And do not do mischief on the earth after it has been set in order. That will be best for you, if you have faith" (Qur'an 7:85).
It is particularly hateful for a guardian to take from an orphan's property. "To orphans restore their property (when they reach their age). Do not substitute your worthless things for their good ones, and do not devour their property by mixing it up with your own. For this is indeed a great sin" (Qur'an 4:2).
Forbidden are earnings from gambling, lotteries, and the production, sale, and distribution of alcohol. "O you who believe! Intoxicants and gambling, sacrificing to stones, and divination by arrows are an abomination of Satan's handiwork. Eschew such abomination, that you may prosper" (Qur'an 5:90).
It is unlawful to hoard food and other basic necessities. Everyone should take what they need and no more. "And let those who covetously withhold of the gifts which Allah has given them of His Grace, think that it is good for them. No, it will be the worse for them. Soon it will tied to their necks like a twisted collar, on the Day of Judgment. To Allah belongs the heritage of the heavens and the earth, and Allah is well-acquainted with all that you do" (Qur'an 3:180).
2. Islamic Banking
A number of economic concepts and techniques were applied in early Islamic banking, including bills of exchange, the first forms of partnership (mufawada) such as limited partnerships(mudaraba), and the earliest forms of capital (al-mal), capital accumulation (nama al-mal),[3] cheques, promissory notes,[4] trusts (see Waqf),[5] transactional accounts, loaning, ledgersand assignments.[6] Organizational enterprises independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced during that time.[7][8] Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.
2.1 Riba
The word "Riba" means excess, increase or addition, which according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). The definition of riba in classical Islamic jurisprudence was "surplus value without counterpart", or "to ensure equivalency in real value", and that "numerical value was immaterial." During this period, gold and silver currencies were the benchmark metals that defined the value of all other materials being traded. Applying interest to the benchmark itself (ex natura sua) made no logical sense as its value remained constant relative to all other materials: these metals could be added to but not created (from nothing).
2.2 Modern Islamic banking
Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950. The writings of Muhammad Hamidullah 1944, 1955, 1957 and 1962 should be included in this category. They have all recognised the need for commercial banks and their perceived "necessary evil," have proposed a banking system based on the concept of Mudarabha - profit and loss sharing.
In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.
3. Commercial Banks
A commercial bank is a type of financial intermediary and a type of bank. Commercial banking is also known as business banking. It is a bank that provides checking accounts, savings accounts, and money market accounts and that accepts time deposits.[1] After the implementation of the Glass-Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital marketactivities. As the two no longer have to be under separate ownership under U.S. law, some use the term "commercial bank" to refer to a bank or a division of a bank primarily dealing with deposits and loans from corporations or large businesses. In some other jurisdictions, the strict separation of investment and commercial banking never applied. Commercial banking may also be seen as distinct from retail banking, which involves the provision of financial services direct to consumers. Many banks offer both commercial and retail banking services.
4. Risks To Islamic Banking
4.1 financial risks
There are several financial risks involved in the Islamic banking system, as there might lack of acceptance and demand for the Islamic banking system in the UK money market therefore it might face difficulties to generate sufficient finances. According to Islamic banking system the borrowing cannot be on the basis of interest so it would be difficult for the Islamic banks to borrow money from other financial institutions working in the UK which lend money against interest. Whereas it would be easier for the commercial banks in the UK to borrow money from other financial institutions as they can agree to pay the interest.
4.2 operational risks
The operations of the Islamic banking system are based on the sharia law which different from the conventional commercial banking system in the UK. As the Islamic banks will have to adapt a standardized banking procedure to match with the baking procedures of other commercial banks, they might face operation problems. There is risk for Islamic banking system that it would not very difficult to them Islamic banks to conduct their operations in according with the other commercial banks in the UK and the Islamic law. The difference between the Islamic banking and the commercial banking in the UK would cause hindrance in the operations of the Islamic banks.
4.3 Business risks
The exposure of the Islamic banking system has been very limited in the UK financial market. The demand for Islamic banking has also been limited so there would be a very high business risk as there is a chance of business failure if Islamic banking system fails to attract more customers and if it fails to create demand for Islamic financial products. The working of Islamic banking system in the UK financial market would be new and experimental and the customers might not be attracted to it as they are attracted to the other commercial banks.
4.4 Event risks
The Islamic banking system follows a set of certain principles and rules which are derived from the sharia law and specific events might restrict Islamic banking system to deal with the issues as commercial banking system would deal. Smaller events might lead Islamic banking system to higher risks and if they are not handled correctly it may lead into greater problems.
4.5 Balance-sheet structure
As we know that the balance sheet represents the financial position of the business unit. The balance sheet represents the Assets, liabilities and the capital. There is difference in the treatment of assets, liabilities and capital of commercial banks and Islamic banks. According to the accounting standards all the limited companies have to disclose all the balance sheet elements in accordance with the International Accounting Standards Board and International Financial reporting Standards so Islamic banks will have to comply with the rules of accounting which might create problems for them where as other commercial banks in the UK follow the accounting standards as part of their accounting policy.
4.6 Internal fraud
The risk of internal fraud would be higher in the Islamic banking system as it would not have the similar standards and policies as the commercial banking system in the UK and the standards of Islamic banking would be novel to implement so there would higher chances of risk. The Islamic baking system would not have a vast base of examples of other internal fraud in the Islamic banks in the UK so it take time from Islamic banks to design a system which would minimize internal fraud risks. As commercial banks in the UK have been working since many years therefore they have a very improved system to minimize internal fraud.
4.7 Macro economic policy risks
The macro economic policy of the UK is keen to control inflation, to reduce unemployment, to minimize national debt and to reduce public spending. To achieve these macroeconomic objectives the government is planning to increase taxes and to reduce interest rates. The Islamic banking system would face problems if the taxes are increased as it would loose profits and commercial banks would benefit if they interest rates are reduce as it would increase the demand for borrowing in commercial banks which would divert the demand from Islamic banks to the commercial banks.
4.8 Political risks
Although there is very less chance of political instability in the UK but there are high chances of changes in the rules and regulations which might effect all the businesses in the UK. The businesses which are already established would not face high risks but the businesses which are relatively newer would have higher risks due to the change in the government policies. As the Islamic banking system is relatively newer in the UK as compared to the other commercial banks so there would be higher risks associated which the political change for the Islamic banking system rather than the commercial banks.
4.9 Income statement
As we know that the income statement represents the financial performance of the business. The Islamic banking system does not aim to generate income on interest where as all the other commercial banks in the UK aim to generate income on the bases of interest. It would not be easy to realise the income of Islamic banking system in the income statement as of other commercial banks so there would be more problems in recording income of the Islamic banks. It would be difficult for the shareholder to assess the income statement of the Islamic bank easily as it would be different from other commercial banks.
4.11 External fraud risks
The risk of external frauds would be higher in the Islamic banking system as the Islamic banking is newer banking system in the UK and it will take some time to establish a system which minimizes the external banking fraud. The risk of external banking frauds is lower in the commercial banks in the UK as compared to the Islamic banks in the UK because the Commercial banks have been operating for a much longer time and they have been able to establish a secure system which minimizes the risk of external fraud for them.
4.12 Legal infrastructure risks
All the banks in the United Kingdom follow the English legal system where as the Islamic banking system is based on the Sharia law which is according to the Islamic legal system and there are differences in the English legal system and the Islamic legal system. All the banks that would operate in the UK will have to follow the English legal system so the Islamic banks will operating the UK will also have to follow the English legal system so there would be risk to cope with Islamic legal system and the English legal system at the same time. It would be difficult for the Islamic banks to have a legal infrastructure which would be according to both the English legal system and the Islamic legal system.
4.13 Banking crisis risk
As the world is in recession and many countries including Ireland and Greece have faced disastrous Banking crisis. There is always a risk of failure for all the banks but this risk is higher for the Islamic banks as compared to commercial banks. The Islamic banking system works on profit sharing bases and if the economy is not performing well the profits of Islamic banks would fall dramatically and the fall in the profits would create problems for credit generation and low credit generation would lead to banking crisis which are a higher risk to the Islamic baking system.
4.14 Credit risks
As its borrow money against interest from the commercial banks in the UK, the demand for credit from the Islamic banks in the UK is lower than the commercial banks. Islamic banks earn on the profit sharing and if they are unable to general profits they would face problems to general credit and they would face higher risk of running low of credit as they cannot lend money on the basis of interest which is easier than the profit sharing method. Islamic banking system would be having higher risks of liquidation as compared to other commercial banks in the UK.
4.15 Client, products, and business services
The client base of the Islamic banking system would be less than commercial banks in the UK so the there would be a risk of reduction in the client base if the Islamic banking system has been unable to attract the customers. The financial products of the Islamic banking system as limited as compared to the commercial banks in the UK. The Islamic banking system has a very limited financial product which might not fulfil the demands of the clients. The business services of the Islamic banks in the Islamic banking system are always limited and it has risk to stay behind the business services as commercial banks have got more business services to offer.
4.16 Regulatory compliance
The commercial banks in the UK are formed according to the regulatory compliance of the UK where as the Islamic banks in the UK are formed according to the Islamic code of conduct. It is difficult for the Islamic banking system to work in accordance with the regulatory compliance of the UK baking system and the Islamic rules. There is a risk that there could be conflict of interest of the two regulatory compliances that the Islamic banking system has to follow. It is easier for the commercial banks in the UK to follow the UK regulatory compliance.
4.17 Market risks
The UK financial market is more feasible for the commercial banks that are already operating in the market. The commercial banks have the financial products that have high value in the UK financial market. The Islamic banking system is not very feasible for the UK financial market as it is more feasible for the Islamic economic system. The Islamic banking system would face market risks as it would not have financial products that would suit the UK financial market as compared to the commercial banks. Market risks may lead to market failures of the banks so Islamic banks have higher risks to fail in the market as compared to the commercial banks.
4.18 Interest rate
The commercial banks in the UK earn profits on the interest basis whereas the Islamic banking system does not work on the interest basis. The interest rates determine the demand for borrowing and if the interest rates are lower the demand for borrowing would increase in the UK financial markets and more people would choose commercial banks to borrow so there would always be a risk for the Islamic banks to loose demand for borrowing. Rise in interest rates would increase the supply of credit in the commercial banks where as it would not increase the supply of credit in the Islamic banks so the Islamic banks would have a risk of limited supply in the event to rise in the interest rates.
4.19 Execution, delivery and process management
Islamic banking system in the UK is not very old, so it has a risk of problems that it would face in execution, delivery and process management. Its not easy for the Islamic banking system to execute deliver and to process management as it is newer banking system in the UK and it is still in the phase of growing and establishing. There would be management hindrances as a newer banking system would be having more risks as compared to more established management of commercial banks.
4.20 Competition risks
The UK financial market is dominated by the commercial banks so the Islamic banking system would have to face a high competition with the other commercial banks in the UK. The Islamic banking system has limited financial services to offer and they have limited business services to render where as commercial banks have more number of financial products to offer and more business services to render. The Islamic banking system would have to face high risk of competition and it would have to provide credit on easier terms to minimize the risks of competition. Commercial banks in the UK have been operating since many years and they are more established so it would take longer for the Islamic banks to establish their market.
4.21 Other exogenous risk
There are some of the other exogenous risks faced by the Islamic banking system as the Islamic banking system would face these external risks in the UK financial market.
