Answer to Question #200796 in Management for M.Imran

Question

Suppose a friend of yours asks you about Islamic banking and he does not believe in Islamic banking as he is on the view that Islamic banks use KIBOR rate while taking profit which is the interest based benchmark of conventional banks moreover Islamic Banks also receive extra money from their customers in case where they make delay in payment.

Required:

How will you satisfy your friend by answering these two questions? 

Answer 1

Islamic banking can be defined as a financial or banking activity that is sharia compliant or follows sharia law and the practicability of its application through the development of Islamic economics (Alharbi, 2015). As per sharia laws earning interest through a banking activity is prohibited and a good example is charging interest on money borrowed from banks.

KIBOR rate is a rate that is used daily as a reference based on the rates of interest that commercial banks lend unsecured loans to other commercial banks at the money market in Karachi. Islamic banks makes profits by using their funds in various trading and investing activities that are sharia compliant and the profit gained thereabout is distributed to the bank depositors as per a pre-agreed ratio.

As per my friend’s question, yes Islamic banking is currently using KIBOR as a benchmark to determine the profit sharing ratio since the market is at its infancy stage. However, in future Islamic banks will have their own benchmark system for determining profit sharing ratio (Ghauri, 2015). However, it should be noted that using an interest based benchmark to determine profit sharing ratio does not in itself deem the transaction as haram or invalid but rather  the nature or the mechanism of the activity or  transaction that deems if a transaction is haram or not.

References

Alharbi, A., 2015. Development of the Islamic banking system. Journal of Islamic Banking and Finance, 3(1), pp.12-25.

Ghauri, S.M.K., 2015. Why interest-rate cannot benchmark for Islamic financial product pricing?. Benchmarking: An International Journal.