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Islamic banking system is a method of banking which neither permits paying interests nor receiving same; as commonly practiced in the regular banking system. This kind of simple banking system can be found in some Islamic countries such as Saudi Arabia, Iran, Malaysia and the Kuwait Financial House among others.
According to M.O Adewuyi, Islamic banking system is an interest-free system because its origin is derived from the book of Allah (Qur’an) and the Sunnah (deeds) of His messenger (Mohammed).
Paying or receiving interest from the bank for a particular amount deposited or borrowed from the bank is strongly discouraged in Islam. The Holy Qur’an Chapter 2:275 is very explicit on the issue of interest.
While deliberating on Islamic interest also called Riba, Jaabir (1958) stated that those who receive interest, the ones who pay it, the ones who keep records of it and those who have concern in it are all the same.
Islamic banking system might be rejected in some societies because of its name, but the system has no connection with Islamic religion, but operates mainly on the principle of equity, equality and treating fellow human according to the dictates laid down by the Holy Qur’an.
Looking critically at our current banking system, one would observe that paying and receiving interests is one of the major challenges facing the banking system today. This has resulted in many awful economic practices in the banking sector such bastardization of the sector, bribery and corruption as well as unethical banking practices grossly contributing to the “stagnant movement” of the economy.
Another problem with paying and receiving interests is that it has led many bank staff to act lawlessly without considering the prescribed ethical code of banking system thereby leading to unreliable and inefficient services, collect bribe before granting loan, deliberately distort and abuse records, gross manipulation and mismanagement, forgeries of all sorts. All of which have contributed to the collapse of many banks. These practices are forbidden and not associated with Islamic banking system.
Over the years, questions have been raised against the introduction of Islamic banking in Nigeria, as many have viewed it as an attempt to finance terrorism or inject Islamic laws and modes of financial operation into our economic and financial system. However, none of the established Islamic banks either in Kuwait or Saudi Arabia have so far been mentioned or related with terrorism. The only part of the Islamic practice engrafted into this kind of banking system is equality and equity treatments of humanity.
In an attempt to support this, M.O. Adewuyi submitted that; the fact that a bank is located in a Muslim country does not mean it is an Islamic Bank. Most of these Banks are connected to Jewish and Crusader Bank overseas.
The system operates on equal profit and loss bases between the banker and customer as they both share the profit and at the same jointly suffer from the loss that may occur from the transactions between them.
The system allows for feasibility study or investigation to be carried out on the trade by the lending banks prior to granting of a loan to ascertain how feasible and viable the business or project is. This would help the banks to predict the possibility of the borrowers’ competence to meet the payback period for the loan obtained.
Collateral security is not heavily relied upon before granting loan in the Islamic banking system. Rather, the bankers are so much interested in the feasibility and viability of the business to which the loan is to be injected. This is not the case in regular banking system where a strong collateral security and high social personality is required before a loan could be granted, added to the high interest rates that make borrowers to suffer from two different psychological traumas. That is, the ordeal of the payment of principal and the lofty interest rates.
This practice has led to the collapse of many Small Scales Businesses which would have helped in economic development and reduce the high rate of unemployment in this nation.
However, bribery may replace the provision of collateral security in the regular banks. This has in many occasions has resulted in non-recovery of loans from the borrowers and the banks as having the so-called non-performing loans. The concrete examples of these are the recent calamity in the Nigeria banking sector, which made six bank Chief Executives to lose their offices.
Apart from the bankers ensuring the successes borrowers’ projects, they also do not release raw cash to the borrowers so as to avoid problems associated with holding liquid cash; rather the bank may appoint some trusted project supervisors to watch over the business/project from the beginning to the agreed payback periods of the loans.
In several occasions, questions have been raise as to likely inflation in the future, inflation does not allow for interest on loans nor does an interest make provision for future unwanted inflation that may decline the principal value of the loans in the hand of borrowers prior to the fulfillment of their obligations to the banks. Of course, any lose of this nature is compensated by the government.
As for the Return on Capital Employed for the banker, Labib (1969) maintained that this issue could be viewed from two perspectives. The Liberals opined that Islamic banks can pay or accept interest if such is not in any way oppressive, while the Orthordox strictly kick against view of the Liberals that the so called interest is purely Haram (forbidden) in Islam
University of Abuja