INTRODUCTION When one mentions banking or financial institutions, Islam banks don’t
necessarily come readily to mind. There are a few reasons for this, one of which is that
Islam banks, which are primarily religious in nature, tend to be vastly different from their
Western counterparts, and could even be considered confusing to them.In this paper, we’ll
examine the Islam economic system, discuss banks and other financial institutions in this
system, and will discuss some of the accounting methods used in such a system. We’ll also
examine current trends and disadvantages of the system as well.Islam banks and financial
institutions do a lot more than the Western banks do (Ariff, 1998). They do so because
Islam is based on religious practices, as opposed to hard-core business practices. Some
experts point out, as well, that Islam banking, because of its nature, is a risky business,
compared to conventional banking (Ariff, 1998). For one thing, risk-sharing forms a strong
basis of all Islamic financial transactions (Ariff, 1998). Basically, everyone earns
something, or everyone loses something in the trade. Banks, however, have put their eggs
in more than one basket (according to Ariff) and have also established their reserve funds
from past profits, so as to offset any potential major losses (Ariff, 1998).For the most part,
Islamic practices when it comes to money don’t adapt themselves very well to more Anglo
methods of accounting or finance (Rahman, 2000). Most experts point out that Islamic
economics tends to work on very different considerations and theories than do Western
economics, accounting and finance (Rahman, 2000).According to much of the literature on
Islam banking (and its accounting practices), three things must be kept in mind. First, it’s
interest free, and this is something we will continue to point out throughout this paper
(Ariff, 1998). The Islam banking system charges no interest for lending money, and this
has created some interesting challenges in terms of reporting and in terms of lending. Still,
for the most part, experts seem to believe that Islamic banks have tended to function well
without having to charge interest – with one of those experts being the International
Monetary Fund (Ariff, 1998).Second, the banking and financial system of Islam is
multi-purpose and not solely commercial (Ariff, 1998). As we see how religion ties into
Islam (particularly in terms of wealth), we’ll be able to explore this concept somewhat
further.Finally, the Islam banking system is very much equity-oriented (Ariff, 1998). There
is an all for one, one for all concept when it comes to sharing the wealth in Islam that is
absent among other Western (or even some Eastern) financial enterprises. HISTORY AND
EVOLUTIONA history of Islam economics and bankingAccording to Ariff (1998), the
first modern experiment when it came to Islamic banking took place in Egypt, with a
downplaying of the Islamic image, for fear that such activities would be considered a
manifestation of Islamic fundamentalism (p. 46) This first form of official banking was in
the form of a savings bank, based on profit sharing, and located in Mit Ghamr in Egypt in
1963 (Ariff, 1998). By 1967, when the experiment came to an end, there were nine banks
throughout the country – and these banks didn’t charge or pay interest (we’ll explore this
concept later on in this paper) (Ariff, 1998). The banks, rather, survived by becoming
involved in trade and industry, either directly or in partnership with companies, and then
shared the profits earned with depositors (Ariff, 1998). As such, these were mostly
saving/investment institutions, as opposed to commercial banks (Ariff, 1998).Other
institutions, such as the Nasir Sociatl Bank and the IDB followed in the 1970s (Ariff,
1998).But by this time, the political climate of Muslim countries was changing, so that
Islamic financial institutions could be established in the open (Ariff, 1998). Other banks
that came out of this period in the Middle East included the Dubai Islamic Bank, Faisal
Islamic Bank of Sudan, Faisal Islamic Bank of Egypt and the Bahrain Islamic Bank (Ariff,
1998). From there, Islamic banking spread to other areas, such as the Asia-Pacific region,
throughout the 1980s (Ariff, 1998).There are also attempts to establish Islam banks in the
west – the Islamic Banking System (Islamic Finance House today) was established in
Luxembourg in 1978 (Ariff, 1998). In addition, there is an Islamic Bank International in
Denmark and the Islamic Investment Company in Melbourne, Australia (Ariff, 1998).
Islam economics todayThe main point of Islamic banking, whether it comes to loans,
credit cards or other financial instruments, is that it is interest free (Ariff, 1998). This is a
point that we’ll be visiting often throughout the rest of the paper, that there basically is no
room for any type of interest charge or payments in the Islam economic system (Ariff,
1998).These days, Islam economics, in general, is based on Islamic law, also known as
Shariah, which tends to govern both secular and religious activities (Rahman, 2000). The
main philosophy behind Shariah is to move society both toward general well-being and
justice from a socio-economic sense (Rahman, 2000). It also promotes the lesson that all
wealth belongs to Allah, while human beings are trustees only of the wealth (Rahman,
2000). In the standard Islamic economic system, there is little of a concept of ownership,
especially as it pertains to wealth. The main point here (again, following the concepts of
social justices) is that no one man can claim for himself what was either created by Allah,
which is a product or service coming from someone else’s efforts and skills (Rahman,
2000).This differs from a Western philosophy of economics which points to the idea that
each individual has absolute rights over wealth, and can do with it what he or she pleases
(Rahman, 2000). Unlike Islam, the goal in Western economics is to maximize wealth,
which is why so many Western corporations talk about the importance of bottom line
accounting (Rahman, 2000). With Islam economics, in general, maximization of wealth is
not the main goal here – but rather, wealth needs to be used in accordance to Allah’s
desires (Rahman, 2000).This means, in a sense, that wealth, instead of being concentrated
in the hands of a few, is circulated throughout society as far and wide as possible, to bring
everyone up to the same economic level (as much as possible) (Rahman, 2000). Balancing
the wealthIslam accounting and economic methods offer a variety of ways to help
distribute wealth throughout society, and one of these is zakat (Rahman, 2000). Zakat, in
its most basic form can be considered a kind of mandatory religious levy on those who
have more wealth; these people are required, by rule of Allah, to contribute to the poor and
needy, without riba, or interest (Rahman, 2000).Zakat, in fact, is one of the fundamental
pillars of Islam – with zakat standing for purification, wealthier individuals are required to
pay zakat to purify themselves from the sin of greed (Rahman, 2000). Zakat is important in
this concept, as experts point out, because zakat is the basis for the Islamic financial
structure (Rahman, 2000). The simple theory behind zakat, once again, is that poverty can
be eradicated by distributing wealth from the relatively rich to those who are poor and
needy (Rahman, 2000). This isn’t charity, but rather, (as we pointed out above), money that
belongs to the poor and needy (Rahman, 2000). Zakat, by its very nature, helps wealth
circulate throughout society, creating a society working on mutual assistance and, in
theory, guarantees a minimum standard of living to all people who survive in Islamic
society (Rahman, 2000).But not all wealthy Muslims participate with zakat – only those
who have wealth above a certain limit (nisab, as it’s called – typically an equivalent of 85
grams of gold), must pay zakat, and this is circulated to those who have accumulated
wealth below the basic limit (Rahman, 2000). Zakat is paid on surplus wealth, not wealth
that is currently in use (Rahman, 2000). In other words, zakat decrees that wealth should
not be hoarded, but rather, invested (Rahman, 2000). This is different from Western
concepts, which can hoard wealth – these are also called savings accounts or money
markets. High cash balances in Islam society is not a good sign. It’s a sign that wealth is
not being circulated in accordance with Allah’s directives.Additionally, capital as a factor
of production works to help keep Islam financial institutions alive (Ariff, 1998). Profit
sharing (as we’ll see) has been a viable alternative when it has come to lending money
(Ariff, 1998). The owner of capital, therefore, can legitimately share profits made by an
entrepreneur (Ariff, 1998). This is one aspect that takes away the interest mechanism in
Islam banking and finance (Ariff, 1998).Profit sharing, it is believed, helps allocate
resources more efficiently, as profit-sharing resources are impacted by market forces
(Ariff, 1998). This happens so that capital flows into sectors offering the highest
profit-sharing ration to the investor (all things, of course, being equal) (Ariff, 1998). How
zakat worksWhile zakat applies to individuals, it applies to business owners (and financial
