An introduction to Islamic banking


This article tells you about the basic concepts and principles of Islamic banking.



Islamic banking is a banking based on Islamic value system and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic law (Shariah). It follows the Shariah, called fiqh muamalat (Islamic rules on transactions).

Interest free banking is a narrow concept denoting a number of banking instruments or operations, which avoid interest. Islamic banking in general not only avoids interest-based transactions, prohibited in the Islamic Shariah, but also avoids unethical practices and participate actively in achieving the goals and objectives of an Islamic economy.



Islamic Shariah prohibits ‘interest’ but it does not prohibit all gains on capital. Islamic principles simply require that performance of capital should also be considered while rewarding the capital.

prudently handle the unique risks involved in management of assets by adhering to best practices of corporate governance.




In Malaysia an Islamic banks is required to set up a Shariah Committee to make sure that it functions in accordance with the Shariah. In addition, the advice of the Shariah Advisory Council which is the highest Shariah body set up at Bank Negara Malaysia, can be sought to ensure uniformity in views and practices. The members of the Shariah Committees and the Shariah Advisory Council are academicians and Shariah experts in Islamic banking and finance.



The common Shariah concepts or modes (in Malaysia) are as follows:


1. Wadiah (Safekeeping)



2. Mudharabah (Profit sharing)

Mudharabah is a form of partnership where one party (investor) provides the funds/ capital while the other (entrepreneur) provides expertise and management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties based on a pre-agreed profit sharing ratio, while loss is borne only by the provider of the capital.


  • A bank as an entrepreneur and the other party as an investor.
  • A bank as an investor and the other party as an entrepreneur.

Process flow:

  1. You supply funds to the bank after agreeing on the terms of the Mudharabah arrangement.
  2. Bank invests funds in assets or in projects.
  3. Business may make profit or incur loss.
  4. Profit is shared between you and your bank based on a pre-agreed ratio.


3. Bai’ Bithaman Ajil – BBA (Deferred payment sale)


Process flow:

  1. You pick an asset you would like to buy.
  3. Bank buys the asset from the owner on cash basis.
  4. Ownership of the goods passes to the bank.
  5. Bank sells the goods, passes ownership to you at the mark-up price.
  6. You pay the bank the mark-up price in installments over a period of time.


4. Murabahah (Cost plus)




5. Musyarakah (Joint venture)

Musyarakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business venture. All providers of capital (a.k.a partners) are entitled to participate in management, but not necessarily required to do so. Profit made will be shared by the partners based on pre-agreed ratios which may not be in the same proportion as the amount of investment made by the partners. However, losses incurred will be shared strictly based on the ratio of funds invested by each partner.


6. Ijarah Thumma Bai’ (Hire purchase)


It involves two separate contracts: Ijarah contract (leasing/renting) and Bai’ contract (purchase). The Ijarah contract is the first of two contracts whereby the customer leases the car from the owner (bank) at an agreed rental over a specific period. The second contract, Bai’ enables the customer to purchase the car at an agreed price after the leasing period ends. The contracts are made one after the other.

Process flow:

  1. You pick a car you would like to have.
  2. You ask the bank for Ijarah of the car, pay the deposit for the car and promise to lease the car from the bank after the bank has bought the car.
  3. Bank pays the seller for the car.
  4. Seller passes ownership of the car to the bank.
  5. Bank leases the car to you.
  6. You pay Ijarah rentals over a period.
  7. At end of the leasing period, the bank sells the car to you at the agreed sale price.

7. Bai’ al-Inah (Sell and Buy Back Agreement)

The financier sells an asset to the customer on a deferred payment and then the asset is immediately repurchased by the financier for cash at a discount.

8. Wakalah (Agency)





9. Qard (Interest-free loan)



  • A lender who lent RM5,000 to a borrower on Qard will expect the
    borrower to return exactly RM5,000 to him at a later date.


10. Hibah (Gift)





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