Commercial banks are the backbone of any economy and they contribute to the economic development in the following ways: 1) Promoting capital formation in the economy 2) Promotion of trade and industry through loans and investments 3) Development of agriculture through Agri-financing 4) Transferring surplus capital from developed to less developed regions to allow for balanced development of the economy 5) Encouraging businesses related to export by providing them support so as to improve the GDP of the country through positive trade (Janan, 2009) b.1. Following are the 5 principles on which the Islamic banking model operates: 1) Sanctity of contract – it must be ensured that the contract is halal (all components valid and not voidable) according to the Sharia rulings 2) Risk Sharing – profit must not be earned by a party without having a stake in the asset generating the said profit 3) No Riba/Interest – money should not be lent to earn additional amount on its underlying value 4) Economic Purpose – the activity should be for economic purpose 5) Fairness – the terms and conditions should be fair to all parties involved and be disclosed fully to avoid any doubt in the contract (Ahmad & Shabbir) b.2. Advantages of Islamic Banking over Conventional Banking: 1) Islamic modes of finance can’t be marketed beyond the initial parties of the contract and are also non-callable – both these features protect the financial system from collapsing. Conventional bank lending is a pyramid-shaped chain where one party can further the loan attained from the bank, thus when a financial crisis occurs and one party defaults the whole system crashes. Also, the non-callable feature allows for more certainty as the party is able to keep the loan until its maturity. (Ahmad & Shabbir) 2) Islamic banks bear the liability of getting involved in a transaction with the customer unlike conventional banks – thus they do not have a guaranteed return in form of fixed payments from customers (interest) rather they take risk of partnering in a venture with their client. For example in Musharika which is a mode of Islamic finance, the bank gets into a partnership agreement with the client and the profit sharing ratio is agreed upon by the parties while the ratio of loss sharing is in proportion to the capital invested by the bank and the client. (Ahmad & Shabbir) 3) The creditworthiness of the client is not the only determining factor in Islamic finance – the type, nature, viability, and profitability of the business are the main determining factors. Islam does not allow unethical and immoral business activities, thus lending to businesses such as alcohol, pornography, etc. is forbidden as these activities are also harmful and negatively affect the productivity of the economy. (Ahamed, 2008)
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7 pages (1750 words)Essay
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