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WHAT IS BANKING?

When we talk about banking, we are discussing the products and services offered by the financial industry including lending money, facilitating payments, and managing accounts. Banking services are available to individuals, companies, and governments. There are some key differences between commercial banking and Islamic banking.

Banks and financial institutions play an important role in the economy. Not only do they facilitate financial transactions, but they also act as intermediaries between businesses, between borrowers and savers, and between lenders and businesses.

Banks facilitate transactions and manage credit and debit accounts. The role in the economy goes beyond managing money. They are also responsible for ensuring the financial systems remain stable, and they are therefore subject to regulation and oversight by central banks.

The regulation of banks ensures that there is ongoing prudent financial management, and risk mitigation in addition to compliance with legal standards.

COMMERCIAL BANKING - HOW DOES IT WORK?

Commercial banking is a traditional form of banking used across the globe, especially in Western economies. In its very basic form, commercial banking relates to the services and activities that banks can provide to individuals, entrepreneurs, businesses and governmental organisations.

Commercial banks undertake various activities, including:

• Payments: commercial banks facilitate incoming and outgoing payments, transfers, cheques.
• Debit and credit cards: commercial banks provide customers with debit and credit cards
• Trading: banks also facilitate national and international trade by enabling international payments and foreign exchange transactions.
• Investment services: commercial banks offer brokerage services and accounts, advisory services, and information about investment options.
• Corporate banking: commercial banks offer the corporate world specialised corporate services to encourage and facilitate corporate trade and transactions.

Main Principles Of Commercial Banking

One of the main underlying principles of commercial banking is the payment and receipt of interest. A commercial bank makes money by earning interest on loans and financial instruments that it provides to businesses, individuals, and large corporations.

Commercial banks also make money from the fees they charge for their products. For example, when offering loans and mortgages, the bank will usually charge a fee for this service.

Commercial banking rests on the following main principles:

• Profitability - as with any commercial business, the banks main focus is on profitability.
• Liquidity - liquidity refers to the ability of assets to be quickly converted into cash/ money.
• Solvency - commercial banks need to be solvent at all times. What this means is that they have financial sufficiency and capability. This level of solvency enables banks to remain in competitive markets with enough capital.

ISLAMIC BANKING - HOW DOES IT WORK?

Islamic banking is very different to traditional commercial banking. Islamic banking is based on Islamic finance principles and guidelines. These guidelines follow Islamic Sharia law. Sharia law prohibits the receipt or payment of interest, as this is considered to be deeply unethical and exploitative.

Sharia compliant banking, underpinned by Islamic finance principles, does not charge or pay any form of interest. This does raise the question of how do Islamic banks make a profit if they do not charge interest to the customer.

The answer to this lies in the structure and the practices within Islamic finance institutions. Instead of making profit through interest, Islamic banks profit through equity sharing and partnership arrangements. These arrangements ensure that the profits and losses are shared between the parties.

Let's have a look at the way Islamic banks operate and how they make a profit:

• Profit and loss sharing - Islamic banks rely on Sharia concepts such as musharaka (cost-plus financing) and mudaraba (partnership based financing). The former requires both the customer and the bank to contribute capital and share in any profits arising from the investment. Mudaraba is a slightly different arrangement where the bank provides the capital and the individual manages the running of the business. Both these arrangements facilitate profit sharing in an equitable way.
• Asset-backed finance - Islamic banks rely on asset-based finance arrangements. Often, this means that the bank or financial institution will purchase an asset at the request of the customer and then sell it back to them. The sale back is at a higher price which is usually paid back in instalments.
• Investments - Islamic banks are permitted to engage in investment activities. However, the difference between Islamic banks and conventional banks is that Islamic banks retain control over the industries they invest in. They do not invest in industries that are deemed to be impermissible in Islam (ie, gambling, porn, alcohol). Additionally, any investment activity is not interest based and is not speculative or uncertain. This means the level of risk is often lower than the investment activities of commercial banks.

Key Principles Of Islamic Banking

As already mentioned above, the main principles relating to Islamic banking are derived from Sharia law. Sharia law guides Islamic finance and differentiates it from conventional commercial banking.

The key principles of Islamic banking are:

• No interest - there is a strict prohibition on interest (riba). This means that any deposit or payment does not accrue or attract interest in any form.
• Profits and losses - Islamic finance centres on the notion of equitable relationships and non-exploitative relationships. This means that there has to be equitable sharing of profits and losses between the parties.
• No uncertainty - excessive uncertainty is not permissible in Islamic banking. This means that any investor, entrepreneur, business, or leader looking to engage in activities needs to ensure that the trade or investment is not uncertain or ambiguous. Financial transactions should be transparent and solution based.
• Ethical and social responsibility - Islamic finance is underpinned by the key concepts of ethical behaviour and social responsibility. There is an onus on those with control to ensure that the parties engage in activity that does not adversely affect others and that benefits society as a whole.
• No speculation - it is important for Islamic banking to ensure that financial activities are based on real economic transactions, not hypothetical or speculative activities.
• No excessive debt - again, to ensure there is equity and transparency, Islamic finance requires that excessive debt is avoided. Islam promotes responsible borrowing and lending practices.

Commercial Banking Services Vs Islamic Banking Services

The main difference between commercial banking and Islamic banking are the main principles which guide the banking activities. As already discussed, Islamic banking does not rely on interest payments or interest based activities.

Whilst commercial banks rely on interest as a fundamental component when it comes to lending and borrowing, Islamic banks are more focused on a profit-loss sharing arrangement.

Whilst both commercial and Islamic banks offer a variety of financial products and services, Islamic banks have to ensure they are compliant with Sharia rules about financial activities. Islamic banks provide similar services to commercial banks (loans, mortgages, savings accounts etc) but the key difference is that they offer Sharia compliant alternatives to their clients.

Islamic banks actively avoid financial deals and transactions that are deemed to be risky and speculative such as derivatives and trading securities. The ethical and social responsibility element of finance is not something that features as heavily in commercial banking as it does in Islamic banking.

Commercial banks aim to generate and maximise profits through interest that is earned on lending and other banking services. For Islamic banks, interest is prohibited, so they look to Sharia compliant ways of generating profits.

It is important to remember that both Islamic and commercial banking aim to offer financial services to meet their clients needs. Islamic banking is favoured by Muslims because the principles of Islamic finance mean they remain compliant with their religious obligations. However, Islamic finance has a much wider appeal to customers across the Muslim and non-Muslim world.

The Regulatory Framework For Banking In The Uk

In the United Kingdom, the regulatory framework is managed by the Financial Conduct Authority.

As part of its supervisory and regulatory role, the Financial Conduct Authority aims to protect the customers of financial institutions that offer any form of financial product or service. The Financial Conduct Authority also ensures that it promotes healthy competition between financial service providers.

Risk Management In Commercial Banking

Risk management and mitigation are essential tasks for banks. Not only does risk management ensure that banks have a risk management strategy in place, but it also ensures banks remain compliant with the relevant regulatory regime in place.

Commercial banks assess risks on an ongoing basis to ensure that they can maintain their financial stability. Risk management also prevents unexpected losses that could occur and help the bank prepare for long-term viability and market fluctuations. Ultimately, commercial banking is arguably more volatile that Islamic banking as it places itself in a more fluctuating, interest and economy based market.

Islamic banking mitigates risk by avoiding interest based transactions, and discouraging speculative behaviour. The risk and reward is shared between the parties, this leads to shared responsibilities when it comes to risk.

Risk Management Is Islamic Banking

Risk management in Islamic banking is different from the risk management in conventional commercial banks.

Islamic finance promotes the forecasting of financial risks and ensures the necessary risk mitigation strategies are in place from the outset. Under Sharia rules and guidelines, Islamic banks manage risk via practices which actively mitigate risk. These practices include ensuring that is an equitable profit and loss sharing arrangements. Islamic finance also requires that parties to a transaction share the risk, so one party is not left dealing with huge losses.

Through intense screening and due diligence, Islamic banks assess feasibility in a more rigorous way than commercial banks. This helps them identify potential issues before they arise and mitigate risks early on.

Islamic banks will usually have Sharia compliant scholars and boards working with the bank and ensuring it is compliant and regulated. These boards provide Islamic guidance on complex transactions and reduce the risk exposure. Many Islamic banks will also ensure they have contingency funds and reserves to deal with unexpected events and losses.

Introduction

Forex trading refers to foreign exchange trading where one currency is traded into another. Forex trading is important in the global markets and economy because it not only facilitates international trade, but is also the biggest financial market globally.

A common question is why does forex matter to the global markets? Not only does forex enable international investment and trade it also leads to financial stability. In order to conduct cross-border and cross-country financial transactions, governments and businesses rely on forex. One example of this is where a European company that is importing goods from the USA is able to exchange euros into dollars.

Central banks use forex to stabilise economies when currencies weaken or inflation increases. Forex ensures that money is able to flow across borders.

To decide whether forex trading is haram or halal depends on the the circumstances of the forex trade. We know that any forex trade that includes interest (riba), gambling (maisir) or uncertainty (gharar) could be deemed to be haram. However, when using interest-free accounts, Islamic forex accounts, and Sharia compliant strategies, forex trading can be done in a halal way.

Key Principles of Islamic Finance

What are some of the key Islamic finance principles to be mindful of when examining forex trading?

The main principles you should know about are:

• Prohibition of riba (interest): any kind of interest element attached to a trade is not permissible under Islamic finance rules. Riba is seen as unjustified financial gain and is haram. In forex trading watch out for overnight interest (swap fees) or interest earnt on sums held overnight.
• Avoidance of gharar (uncertainty): any significant uncertainty could render the forex trade haram. Avoid high-risk and speculative trades especially where traders gamble on price movements that have no real economic value. Similarly, avoid traders who trade without any underlying asset (see below). Uncertainty also applies to contract terms. If a trader has hidden fees or complex conditions then this needs to be challenged.
• Avoidance of maisir (speculation/gambling): Islam prohibits gambling and this also applies to trades where financial gains are linked to luck and unearned income. High-frequency and high-risk trades are best avoided.
• Ethical trading: trades and transactions that happen instantly such as spot forex trades (T+ 0 rule) are better than derivatives and futures that relate to settlements in the future.

The Halal Perspective

Forex trading is considered halal when conducted through Islamic accounts with zero interest. There are Islamic forex traders who adopt ethical practices in line with Islamic finance rules, ensuring adherence to Sharia law. The benefit for Muslims is that they can participate in investing and trading without breaching Islamic rules.

As a simple exchange of currencies, the following conditions can render a forex trade halal:

• Islamic swap-free accounts: these accounts are not interest-based and adhere to Islamic finance principles.
• Clear contracts: ensure you have transparent contract terms and pricing with real market involvement.
• Avoid gambling on price movements and work with experienced knowledgeable traders who understand Islamic finance and who are not single-mindedly focused on the margin or return for the parties.
• spot-trading: focus on actual asset ownership and immediate settlement rather than delayed settlements.
• Make sure your dealings are not gambling, but based on legitimate business trades.
• Day trading vs swing trading: day trading includes buying and selling on the same day. No positions are held overnight therefore the chance of incurring interest fees or swap fees is eliminated. Swing trading involves holding positions for many days at a time and this can include interest fees which are haram.

The Haram Perspective

Conventional forex trading is considered to be haram where there is interest payable/charged, and where there are elements of gambling or uncertainty. Always find out as much information you can about the broker, account, process and industry you are engaging with before starting any trading activity.

There are many Islamic brokers and experts that can help you navigate away from haram practices when it comes to currency trading and markets.

Avoid the following practices

1. interest payments.
2. hidden fees.
3. sudden changes in price.
4. manipulations by the brokers
5. excessive uncertainty and ambiguity
6. swap fees (eg overnight payments)
7. exploitation of others in trades
8. trades on market movements without understanding the fundamentals of the market
9. borrowing large amounts of money/ loan (leverage) which is often linked to riba and increased risk

According to Islamic scholars and the Fiqh Council, conventional forex trading is haram when rooted in traditional trading practices. Conventional trading practices go against Islamic beliefs and values relating to financial activities.

However, forex can be halal if:

• you use transparent traders and brokers with Islamic finance knowledge
• you use Islamic accounts with no interest (swap-free accounts)
• you conduct trades on real economic analysis and foundations
• pick Islamic-compliant brokers and organisations
• you avoid speculation, gambling and deception,
• you focus on immediate settlement and future payments
• your trades are based on real asset ownership
• trade using your own capital and not borrowed sums

Frequently Asked Questions

● Is forex trading a form of gambling?

Unless forex trading takes place within an Islamic finance framework (using Islamic accounts and knowledgeable brokers who understand the religious principles of Islam) then it could be deemed to be gambling. When conducted within Sharia rules, forex can be halal.

● How do Islamic accounts work?

Simple speaking, Islamic forex accounts avoid interest payments and interest rate calculations, and are created specifically to comply with Sharia rules about financial transactions.

● Is leverage allowed in Islam?

Leverage refers to traders borrowing money from other brokers to increase their potential profits. In traditional forex trading accounts leverage often includes interest payments on borrowing. Is Islam, leverage is allowed as long as there is no interest payable on leveraged funds.

● Can I trade forex without interest?

Yes, of course. Islamic forex accounts enable Muslims and ethical investors to trade without receiving or paying any interest. Islamic swap-free accounts were created as a solution for Muslim customers and are available on the market that are tailored to ensure they comply with Islamic finance principles.

Conclusion

Ultimately, whether or not forex trading is halal or haram depends on whether the trade itself complies with Islamic finance principles. Islamic scholars and experts can provide guidance and specify trading practices that are haram to help clarify if trading is halal or haram. However, by choosing Sharia-compliant brokers and accounts and focusing on ethical trading there are many ways of engaging in forex trading in a halal way.

There are obvious red flags to avoid for any Muslim (riba being one of them), but there are ways of ensuring that trades are halal. One of the best things you can do before any kind of financial investment or trade is to seek the advice of Islamic scholars and then speak to Muslim forex traders. These people are best placed to ensure that any trade you undertake is halal and remains compliant.

Remember, even Islamic accounts change over time so you need to ensure that there are proper risk management and risk mitigation strategies in place. Exercise caution, if something looks like it is too good to be true then the onus is on you to dig deeper.

Whether you are a beginner or seasoned investor, when it comes to halal investment this article will explain everything you need to know. This guide is your gateway to understanding Islamic finance, investments, assets, and the value of making informed investment decisions.WHAT CONSTITUTES INVESTMENT?

Investment refers to the process of buying assets with the aim of the assets increasing in value over time. As the value of the asset increases, the investor is provided with a return that takes the form of capital gains or income payments. Investment has historically always been associated with the growth of wealth and the pursuit of capital income. However, investments can also be a means to improving lives and the lives of those in your community.

Investing becomes profitable when the asset you invest in increases in value and you are then able to sell it at a higher price. When the asset increases in value this is known as appreciation.

Investment can be complex and fraught with risk and technical difficulties. Add in the Sharia rules and the world of halal investment can seem increasingly daunting for Muslims. Sharia compliant trading and investments are those investments that do not breach the Sharia rules which are based on the idea of ethical investment and saving. Islamic finance principles relating to finances and investment are based on social justice, non-exploitation, and halal investments that lead to a mutually beneficial partnership.
WHAT IS SHARIA COMPLIANT OR HALAL INVESTING?

Halal investment refers to the investment of money in accordance with Islamic finance principles. Sharia finance law is centred on the concepts of social justice, ethics, and using finances to help build communities. For any Muslim considering halal investment strategies, the focus should be partnerships that are mutually financially beneficial.

Sharia law lays down principles and regulations Muslim investors must comply with if they want to invest in halal products. According to Sharia rules, compliance with Islamic finance principles leads to a more ethical and just society. This goes against the western notion that making money is the ultimate aim for investors. Whilst Islamic finance does not prohibit making money, it does place emphasis on ethics and justice, so that a balance is achieved between religion, family, life, intellect, and property.

Halal investments should not be dismissed by those wanting to generate income. Islamic finance is not restricting or limiting, it simply proposes ethical practices and mutual benefit. Halal investments encourage Muslims to invest responsibly and always ethically. It is still very possible to make money ethically with the right investments. Investing within Sharia compliant products actually reduces the risk for investors, and is one of the reasons that Islamic banks were able to withstand the economic collapse in 2008.

Investment And Islamic Finance Principles

Islamic finance principles provide financial principles for Muslim investors to operate within to ensure that the financing and investment activities comply with Sharia law. Whilst the main principles of Islamic finance have been around for centuries, formal Islamic banking and finance was established in the 20th Century.

As the global Muslim population continues to grow, so too does the demand for Islamic finance products and banking. The Islamic finance sector is increasing in size every year, with Islamic finance institutions overseeing over $2 trillion.

The core difference between traditional investment and Islamic investment is that Islamic finance principles dictate what investments are deemed to be halal or not. Islamic finance needs to comply strictly with Sharia law, and the following Islamic finance principles are expressly prohibited:

Paying And Charging Interest (Riba)

Interest payments, or investments that include an interest element, are strictly prohibited in Islam. Charging interest is not considered to be Sharia compliant as it is deemed to be an exploitative practice.

Risk And Uncertainty (Gharar)

Sharia rules do not allow participating in contracts where there is excessive uncertainty or risks. Investing or partaking in any short-selling or uncertain contracts are forbidden in accordance with Islamic finance principles.

Investing In Prohibited Activities

For Muslim investors, investment in any business that is involved in prohibited activities such as gambling, and selling alcohol is prohibited.

Speculation (Maisir)

Sharia law prohibits speculation or gambling. So, if any form of investing includes contracts where the ownership is dependent on events in the future that are uncertain, this is deemed to be precarious.

Benefits Of Halal Investments

As the Muslim economy continues to increase year on year, the Islamic finance industry is also growing to cater for the need for growing halal investment options and products. Some of the main benefits of halal investments for Muslims (and no-Muslims) include the following:

• Social Responsibility - taking a socially responsible approach to finances and investment not only means the investment is Sharia-compliant, but it can also lead to human rights protections, just distribution of wealth, and ethical investments that minimise environmental degradation.
• Less Risk - Islamic finance principles mean that halal investment products are less susceptible to huge market changes and fluctuations. Global crises do not impact Islamic finance as they do more traditional banking. As short term speculation is discouraged in Islam, the exposure is much lower overall.
• Growing wealth in a halal way - this is the most critical benefit for Muslim investors. Not only does halal investment mean that Muslims can engage and involve themselves with global markets, it also means that Muslims partake in disciplined investment that requires ethical due diligence.

Stocks, Bonds And Shares

Stocks, bonds and shares are the most common publicly traded investments. Stocks are essentially ownership shares of companies that have publicly traded. A stock is a share of the companies earnings and assets, owning one stock is equivalent to owning a part of the company. If the value of the company increases then the value of the stock increases at the same rate. Similarly, if the market value of the company decreases then so will the value of the stocks owned. Muslim investors who purchase stocks will want to know the modus operandi of the company so that they can be sure that any income derived from their stocks is Sharia compliant.

Bonds are ownership shares of debt, and are usually interest-bearing. This means that the bond effectively acts as a loan to the company. On the whole, bonds are not considered to be a Sharia compliant investment as they are rooted in interest payments. Sukuks are a more acceptable form of Islamic finance bond (see below).

Gold

In terms of investment, gold is considered a safe and traditional means of investment that is Sharia compliant. Gold often appreciates in value, is easy to obtain and invest in, and is not deemed to be in breach of any Islamic finance laws.

Sukuk

Sukuks are an alternative to traditional bonds as they do not bear any interest. They are often referred to as Islamic bonds, and are normally asset based. They are deemed to be conservative investments on the basis that they form part of the 'fixed income' market.

Sukuks are able to generate income for halal investors without breaching the Sharia rules.

Property

Investing in property is a great way for Muslims to invest. The only caveat is that if a mortgage is obtained it is deemed to be a halal mortgage without any element of riba.

Prohibited Industries

Any halal investment must be in accordance with the Sharia principles mentioned above, and must be done with consideration of ethics and social justice. Companies whose main business goes against the central tenets of Islam are considered universally unacceptable as investment opportunities.

There are certain industries that are deemed to be unethical or at risk of causing harm to society, and Muslims should therefore avoid opportunities in these sectors:

• Industries manufacturing, promoting, advertising, or selling alcohol
• Industries manufacturing, promoting, advertising, or selling cigarettes or drugs
• Banking products or financial transactions that include interest (riba)
• Any industries related to gambling
• Industries related to prostitution or pornography
• Industries relating to pork

Sharia law prohibits investing in industries and businesses where at least 5% of their income comes from unethical sources (this is known as the 5% rule). Before investing in any business, Muslims should check out the financial statements and positioning of the company and do some research on their sources of income and profits and where they are derived from.

Halal Investment - What To Look For

When undertaking due diligence prior to investing, you should consider the following 3 types of investing opportunities:

1. Companies with halal practices - these are known as clean companies (from a halal investment perspective) and are companies that operate in a completely halal way. These companies operate within the Sharia finance rules, and have a clear halal audit trail.

2. Companies with haram practices - these types of companies operate within prohibited industries such as gambling and alcohol.

3. Mixed companies - these companies may have halal practices but these are mixed with haram practices or activities.

For halal investors, option 1 is always the best option as there is no overlap of the halal-haram considerations. Companies that have a cross-over between halal and haram should be avoided.

As one of the fastest growing finance sectors, Islamic finance has opened up many opportunities for halal investors. In the UK alone, there are many banks that offer specialist investing products, loans, and savings accounts.

Conclusion

Islamic finance promotes the concepts of ethical financial management and investment and reciprocal profits. The use of interest, risky investments, and unethical industry investment is discouraged. Halal investing is a growing financial niche, and it is available for Muslims and non-Muslims alike. Investing in products that are Sharia compliant is not difficult or impossible, it just requires some information gathering and due diligence.

Prominent private equity institutions like Gobi Partners have realised the growing demand for halal financial products. Over the last decade, more and more financial institutions and foreign exchange markets have taken steps to place themselves in the Islamic finance and private equity market. High net worth individuals in emerging markets such as Africa and the Middle East are entering the private equity investment market rapidly and this has led to an increase in demand for Sharia compliant investment opportunities. Islamic finance is no longer considered to be a niche and exotic sector within the banking industry.

Of course, the most important factor behind the growth of the Islamic finance industry is that Muslims make up almost a quarter of the world's population. The Muslim investor base is large and it is growing. This growth has not been lost on wealth managers and banks who are keen to tap into the wealth and investment funds in the hands of wealthy Muslims. Coupled with the economic expansion of many Muslim countries, it is likely that halal investment products will become more accessible within the next 10 years.

As the Islamic finance sector continues to grow annually, a faith-based approach to investing and trading is becoming more mainstream. However, the application of Islamic finance to investment products needs to be undertaken and can be nuanced, so always make sure to check the financial information of any company you are considering investing in.