system, other than sharing profit based on an agreed-upon ratio (nisbah), there is also a sharing of risk. This is different from methods involving the conventional bank, in which the whole loss is borne by the entrepreneur or borrower.
An Islamic Bank Deals in Real Goods or Services, Not in Money
According to an Islamic perspective, money functions only as storage of wealth and a medium of exchange, not as a tradeable commodity. Because of this, Islam prohibits the sale of money with money in deferred payment/goods delivery, because this is part of usury. Money cannot be sold for a profit. With the lack of interest over loans, Islam offers a solution in the form of interest-free financial products. The transaction can be in the form of sales, profit sharing, or leasing. In sale contracts, the goods sold are real goods.
In a profit-sharing contract, the business receiving the financing should also produce real goods and services and have viable future prospects. Even more important is to change the paradigms of the bankers; in conventional banking methods, the bankers only consider how to locate prospective financing payments, finance those proposals, and ensure that the bank's funding channeled by the bank will be returned along with a predetermined rate of return. When a proposal is approved and funded, the bankers are more focused on capital recovery than on ensuring that the debtors' businesses have developed according to their expectations. Why does this happen? Because the success of the debtors will not impact the return that they will receive; the bankers will only receive the return in terms of the interest rate that is predetermined at the beginning of the contract. Because of this, the bankers have no real incentive to help develop the debtors' businesses. The bankers' only concern is in recovering the principal of their loan along with its interest. They only enter into an assistance process and intensive oversight when any of the debtors' businesses experience trouble. Once more, the motivation here isn't to ensure the debtors' businesses overcome their troubles and experience success, but only to ensure the return of the bank's capital and its interest. This way of thinking is one that should be eliminated once a banker has crossed over (hijrah) to the Islamic banking system.
The same beneficial effect to society should also apply to lease contracts: the object being rented should be a real object and capable of being handed over. The renter receives benefit (usufruct) from the object being rented. In Islamic finance, the ijarah contract (leasing) entered into by the bank can only be of the form of operating lease, not of capital lease. With regards to the asset, the bank can either own the asset whose benefit (usufruct) will be rented out, or the bank could enter into an ijarah contract with the first party, to then rent it out to the second party (this is called a parallel ijarah) as long as the first party does not stipulate that the asset cannot be entered into a second ijarah contract.
History of the Islamic Bank
An early experiment in modern Islamic banking was initiated by Abdul Aziz Ahmad El-Najjar through Myt-Ghamr Bank, established in 1963 in Egypt. With assistance in capital from King Faisal of Saudi Arabia, the Myt-Ghamr Bank was considered successful in combining German banking management with Islamic finance principles and translating that into banking products that are suitable for rural areas mostly oriented toward the agricultural industry. Due to political reasons, the Myt-Ghamr bank closed in 1967.
Initial ideas on the establishment of Islamic banks internationally began in an OIC conference in Kuala Lumpur in 1969. The participants agreed on several things, the first being that every profit must be based on the principle of profits and loss sharing, and if not, the profit would fall under the category of usury, which is prohibited in Islam. Secondly, it was recommended that an Islamic bank free from the usury system be established quickly, and that in the interim, before the establishment of such a bank, the conventional banks would still be allowed to operate as long as it were a matter of emergency. Based on the recommendations from the Islamic Economy Conference in Mecca, the Islamic Development Bank (IDB) was established in 1975. IDB had an important role in fulfilling the financing needs of Islamic countries to build infrastructure and actively provide with an interest-free guarantee based on the country's capital. The establishment of IDB also motivated many other countries to establish Islamic financial institutions.
The first Islamic bank established was a private one. Built by a group of Muslim businessman from various countries, the Dubai Islamic Bank was established in 1975. In 1977, two more Islamic banks were established: Faysal Islamic Bank in Egypt and Sudan, and Kuwait Finance House established by the Kuwaiti government. Bahrain Islamic Bank was established in 1979. Philippine Amanah Bank was established in 1973, based on a presidential decree, and Muslim Pilgrims Savings Corporation was established in 1983 in Malaysia. At the beginning of the 1980s, various countries hosted emerging Islamic banks of two general types: Islamic commercial banks and Islamic investment institutions.
Global Islamic Banking Entities
The banking system in a country could not stand alone only by relying on banking institutions and regulators in domestic level. There are some organizations at the global level that have roles in providing guidance regarding best practices for the banking industry and regulators in every country. It also applies to Islamic banking, for which there are some global organizations such as IDB, IFSB, and AAOIFI, and other organizations that have different roles and functions. Those organizations synergize to maintain the banking practice so that it still runs in accordance with syari'ah principles and good governance.
Islamic Development Bank (IDB)
IDB is an international financial institution established to follow-up on the results of the conference that finance ministers from various Islamic countries held at Jeddah in December 1973. Based on the results of the meeting of the Board of Governors on July 1975, the IDB was officially in operation on October 20, 1975. The purpose of the establishment of the IDB was to assist the social and economic development of its member countries and Muslim society, according to Islamic principles. IDB also provided loans and capital for projects and productive enterprises, as well as financial assistance to member countries in other forms for the purpose of social and economic development. IDB was given the authority to receive deposits and to mobilize financial resources through the appropriate Islamic mode. Other than that, IDB was also responsible for assisting international trade promotions, especially for capital goods, among the member countries; providing technical assistance for member countries; and providing training facilities to support the development of the application of Islamic principles in Muslim countries.
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
The AAOIFI was established in 1990; it is an independent, international organization supported by 200 member institutions from 45 countries, covering central banks, Islamic financial institutions, and other financial institutions in the Islamic banking and finance industry. As of this writing, AAOIFI has already published 50 standards for accounting, auditing, ethics, and other syari'ah standards. Even if they are not binding, with the publication of the standards it is hoped that all Islamic financial institutions and regulators managing how Islamic finance is practiced in each countries apply a uniform standard. The purpose of the establishment of AAOIFI was to develop accounting, auditing, governance, and ethics for various activities of Islamic financial institutions to make sure that they are in accordance with Islamic principles as well as international standards and practices; to reconcile accounting procedures and policies used in Islamic financial institutions with the same standards and interpretations used in their conventional counterpart; and to issue a syari'ah standard in relation to the concept and application of a syari'ah supervisory board in each Islamic financial institution to prevent contradiction and inconsistencies between fatwas and their application.
Islamic Financial Services Board (IFSB)
The IFSB is an international organization drawing up the principles, guidance, and standards in the banking, insurance, and capital market sectors with the purpose of supporting
