The core of Islamic banking and conventional banking is the same – to address the financial needs of the bank's customers. The difference lies in the treatment of how this is achieved.
Islamic banking is based on Shari'ah law. Broadly speaking, Shari'ah law dictates the exclusion of things it finds objectionable, like "riba" (interest), prohibition of Masir (intoxicants), "Qimar"/"maysir" (gambling) and "gharar" (uncertainty). Islamic law prohibits usury, which is giving and receiving interest on funds—a major component of banking. As such, Shari'ah law and its principles consider banking to be risk-sharing rather than financing based on a fixed pre-determined return. Based on these tenets, it is important to consider how transaction banking can be conducted in accordance with Shari'ah law.
The growth of Islamic banking has been gradual and has evolved to include a number of products and services over the years. As technology was introduced in the banking world, Islamic banking also adopted various technology solutions to adapt to the changing scene. Various vendors started providing products and services to meet the requirements of Islamic banking. The key factors that need to be included in any Islamic banking solution include the following:
Structure of products and services A key component of Islamic banking is that products and services meet specific requirements and have an appropriate audit trail to prove that transactions comply with Islamic accounting. For example, this style of accounting must use the Hijri calendar, which follows the lunar cycle and has 354 days.
Compensation for services provided Interest-based charges are not suitable for Islamic banking. Therefore, the method adopted to charge for services will need to be based on counts and volumes and could include a pre-determined profit element.
Transaction accounting The solutions designed for Islamic banking should be compliant with Islamic banking standards based on the guidelines provided by AAOIFI (
Requirements of the functional services for transaction banking The various components of transaction banking—liquidity management, pooling, payment systems, trade services—all need to be calibrated for Islamic banking. As discussed, all interest-based transactions in conventional banking need to be excluded. The concepts of Istisna (leasing), Murabahah (sale of goods at a price) or Musharakah (capital contribution and sharing profit or loss pro rata basis) are required to be incorporated. This guarantees that all parties are equal stakeholders in case of profits or losses, sharing the inherent risks of the business. All products and services must be compliant with Islamic banking standards and approved by the relevant Shari'ah boards.
The future course of action
Today, Islamic banking is growing rapidly and there are 600 financial institutions across 75 countries offering Shari'ah-compliant products and services. This provides a window of opportunity to design and provide products and services in tune with the specific requirements of Shari'ah law. Here are some of the various factors that will need attention as Islamic banking gains popularity:
Participating financial institutions must have robust solutions that support business rules with regard to Islamic accounting, including the Hijri calendar and concept of profit sharing.
Technology functionalities should support various transaction banking products and services. Systems should have an accounting structure for front- and back-office transactions, using straight through processing (STP) capabilities wherever possible and preferably in service oriented architecture (SOA) platforms.
There should be multi-currency, multi-branch capabilities to allow in-country and cross-border transactions.
The calculations for cash pooling and profit-sharing should be in accordance with Islamic laws.
The calculation and application of charges should be parameterized and automated wherever possible.
There should be a comprehensive audit trail that traces the complete transaction.
The international Islamic financial market is becoming increasingly dynamic and diversified. However, the areas of treasury and liquidity management still need to evolve. There is a need for change in legal, regulatory and tax environments before Islamic finance can become a mainstream offering. Additionally, the interpretation of the Shari'ah law must be standardized.
Islamic finance comprises approximately 1.6 per cent of the world's total financial assets and has grown at an average annual rate of 15-20 per cent over the past decade.* Besides the countries belonging to the
*KFH Research Global Islamic Finance Jurisdictions – 13Sep2013 -finance-jurisdictions">http://www.kfhresearch.com/product/global-islamic-finance-jurisdictions and
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