Understanding Islamic Banking

There are more than 300 banks and 250 mutual funds around the world that comply with Islamic
principles. Between 2000 and 2017, Islamic banks' capital grew from $200 billion to close to $2
trillion and are projected to grow to $3.5 trillion by 2021, according to 2016 Thompson Reuters’
report. This growth is largely due to the rising economies of Muslim countries (especially those
that have benefited from the rising price of oil). Islamic banking is grounded in the tenets of the
Islamic faith as they relate to commercial transactions. The principles of Islamic banking are
derived from the Qur'an–the central religious text of Islam. In Islamic banking, all transactions
must be compliant with shariah, the legal code of Islam (based on the teachings of the Qur'an).
The rules that govern commercial transactions in Islamic banking are referred to as Fiqh al-
muamalat.

Bankers who are employed by institutions that abide by Islamic banking are entrusted with not
deviating from the fundamental principles of the Qur'an while they are conducting business.
When more information or guidance is necessary, Islamic bankers turn to learned scholars or use
independent reasoning based on scholarship and customary practices. One of the primary
differences between conventional banking systems and Islamic banking is that Islamic banking
prohibits usury and speculation. Shariah strictly prohibits any form of speculation or gambling,
which is referred to as maisir. Shariah also prohibits taking interest on loans. In addition, any
investments involving items or substances that are prohibited in the Qur'an—including alcohol,
gambling, pork—are also prohibited. In this way, Islamic banking can be considered a culturally
distinct form of ethical investing. 

To earn money without the typical practice of charging interest, Islamic banks use equity
participation systems. Equity participation means if a bank loans money to a business, the
business will pay back the loan without interest, but instead gives the bank a share in its profits.
If the business defaults or does not earn a profit, then the bank also does not benefit. In general,
Islamic banking institutions tend to be more risk-averse in their investment practices. As a result,
they typically avoid business that could be associated with economic bubbles.

While an Islamic bank is one that is entirely operated using Islamic principles, an Islamic
window refers to services that are based on Islamic principles that are provided by a
conventional bank. Some commercial banks offer Islamic banking services through dedicated
windows or sections.

The practices of Islamic banking are usually traced back to businesspeople in the Middle East
who started engaging in financial transactions with businesspeople in Europe during the
Medieval era. At first, businesspeople in the Middle East used the same financial principles as
the Europeans. However, over time, as trading systems developed and European countries started
establishing local branches of their banks in the Middle East, some of these banks adopted the
local customs of the region where they were newly established, primarily no-interest financial
systems that worked on a profit and loss sharing method. By adopting these practices, these
European banks could also serve the needs of local business people who were Muslim.
Beginning in the 1960s, Islamic banking resurfaced in the modern world, and since 1975, many
new interest-free banks have opened. While the majority of these institutions were founded in
Muslim countries, Islamic banks also opened in Western Europe during the early 1980s. In
addition, national interest-free banking systems have been developed by the governments of Iran,
Sudan, and (to a lesser extent) Pakistan.

What Is the Basis of Islamic Banking?

Islamic banking is grounded in the tenets of the Islamic faith as they relate to commercial
transactions. The principles of Islamic banking are derived from the Qur'an–the central religious
text of Islam. In Islamic banking, all transactions must be compliant with shariah, the legal code
of Islam (based on the teachings of the Qur'an). The rules that govern commercial transactions in
Islamic banking are referred to as Fiqh al-muamalat.

How Do Islamic Banks Make Money?

To earn money without the typical practice of charging interest, Islamic banks use equity
participation systems, which is similar to profit sharing. Equity participation means if a bank
loans money to a business, the business will pay back the loan without interest, but instead gives
the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also
does not benefit.
Challenge Islamic Banking In Digital Era

Concerning to the weakness, the fintech which will be implemented in Islamic banking
institutions has the following weakness analysis:
1) Weaknesses of supporting facilities and infrastructure. The use of fintech is needed by a
conducive internet connection, both in terms of access speed and stable server in sending
data files, because financial transactions will take place smoothly when internet access is
not interrupted. Likewise, there is still an imbalance in access to banking services
because the communication technology infrastructure is not evenly distributed between
regions.
2) Technology crime. The use of information technology has the weakness of the emergence
of online crime actions such as wiretapping, burglary, and cybercrime in financial
transactions. So as to make people hesitant to make online transactions. Whereas what
they need is getting comfort and security. Therefore, the presence of institutions that play
a role in supervision, policymakers such as the Financial Services Authority, Bank
Indonesia, the Ministry of Information and Communication and other relevant institutions
are very much needed.