Islamic Banking

Islamic Banking

Mervyn K. Lewis and Latifa M. Algaoud

The prohibition of interest is the feature of Islamic banking which most distinctly sets it apart from conventional banking. To Western eyes, this seems a strange restriction, but Christian countries themselves maintained such a ban for 1,400 years. Islamic Banking asks why Islam has been able to maintain its stand. The book explores the intricacies of Islamic law and the religious and ethical principles underpinning Islamic banking. It then considers the analytical basis of Islamic banking and financing in the light of modern theories of financial intermediation, and identifies the conceptual issues to be overcome.  

Chapter 3: The Basis of Islamic Banking

Mervyn K. Lewis and Latifa M. Algaoud

Subjects: economics and finance, financial economics and regulation, islamic economics and finance, money and banking


THE PROHIBITION ON RIBA By definition, an Islamic bank abides by Islamic law, the shari’a. The preceding discussion makes clear that a number of elements are involved: (i) (ii) (iii) (iv) (v) riba is prohibited in all transactions; business and investment are undertaken on the basis of halal (legal, permitted) activities; transactions should be free from gharar (speculation or unreasonable uncertainty); zakat is to be paid by the bank to benefit society; all activities should be in line with Islamic principles, with a special shari’a board to supervise and advise the bank on the propriety of transactions. Of these, the first is central. Islamic finance, like Islamic commercial law in general, is dominated by the doctrine of riba. Before examining the basis of Islamic banking, it is important that we understand the nature of, and reasons for, this prohibition. Nature of Riba A general principle of Islamic law, based on a number of passages in the Holy Qur’an, is that unjustified enrichment, or ‘receiving a monetary advantage without giving a countervalue’, is forbidden on ethical grounds. According to Schacht (1964), riba is simply a special case of unjustified enrichment or, in the terms of the Holy Qur’an, consuming (that is, appropriating for one’s own use) the property of others for no good reason, which is prohibited. Riba can be defined formally as ‘a monetary advantage without a countervalue which has been stipulated in favour of one of the two contracting parties in an exchange of two monetary values’ (p. 145)...

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