Islamic Banking Operations; Principles, Sources and Application of Funds

Islamic banking is a part of the broader concept of Islamic Economics, the aim of which is the application of the value system and principles of Islam into the economic domain. Because of this ethical foundation, Islamic banking has more social relevance than merely a commercial transaction. An Islamic bank is a deposit-taking banking institution which practices all conventionally known banking and financial activities except activities related to interest and uncertainty.

Principles of Islamic banking

• Any predetermined payment of over the actual amount of principal (Interest) is prohibited.
• Financial activities should be on the ‘Profit and Loss Sharing’ principle
• Financial activities should be exempted from to Gharar and Maisir.
• Financial activities and investments should be in Sharia Permitted business only.
• Islamic Banks should follow the financial ethics and prohibitions in Sharia.

Sources and application of funds

The deposits from customers are the main source of funds for both conventional and Islamic banks; but the difference between the both is that, while the conventional banks obtain the funds through means of Interest proving banking accounts, the Islamic banks obtain the funds through the Profit and Loss sharing banking accounts.  The efficiency in rising and application of the fund is the reason for the growth of any bank; hence, the banks try to develop more attractive deposit accounts and selling a variety of financial products to its customers.

The efficient application of the fund decides the growth of any financial institution. While the conventional banks invest the raised funds in interest-bearing products and ventures to make profits, Islamic banks invest the raised funds in ventures on profit and loss sharing basis.