Md Abdus Salam in the third of his four-part article entitled 'Necessity of alternative financial system'

From the operational point of view, the Islamic banking system is based on prohibition of interest rates and sharing risks with the loan recipients and the investors. Conventional banks' capital intermediation activity is based on payment of an interest rate and is determined in the percentage of a stake set in the contract.

Islamic banking has shown a new conception of the relationship between economic activity and religion. Its "raw material" is not money but a new network of relations, collaborations and participations, not aimed at dividend maximisation but a new approach to the conduct of business, in which moral motivations and sustainable development could find a place.

Objectives of Islamic banking: In line with the principles of maqasid-al-shariah, Islamic banks pursue the following objectives in their operations:

n Support promotion of economic development with distributive justice.

n Optimum allocation of scarce resources by allocating financial resources in terms of profitability.

n Ensure equitable distribution of income and resources among the participating parties: the bank, the depositors and the entrepreneurs.

Strength and efficiency of Islamic banking: Islamic banking, essentially known as profit-loss-sharing banking, is conceived as more production-oriented and growth-promoting than conventional banking. This is because such a bank's earnings are directly linked to the earnings generated from the venture financed by it. Further, replacement of interest with the principle of profit-loss sharing increases the opportunity of investments in an economy. It also promotes efficient allocation of financial resources, ensures equitable distribution of income and promotes stability in the economy. Thus, Islamic banking is efficient by all macroeconomic efficiency considerations.

Investment decision in conventional banking: In conventional banking, the rate of return to the bank is fixed regardless of the profitability of the project it has financed. The case is opposite what happens with the Islamic banking.

Investment decision in Islamic banking: Under Islamic banking (technically known as the profit-loss sharing system of investment financing), the bank receives a variable rate of return as it shares a percentage of the profit earned by the entrepreneur. Thus, the profit-loss-sharing system of investment financing may be termed a Variable Return Mechanism (VRM). Since the Islamic banking system does not charge interest on any financing transaction, neither the bank nor the client receives or pays a fixed rate of return on an investment financed.

Efficient allocation of resources and Islamic banking: The Islamic banking system is very efficient in allocating resources in the economy. Allocation efficiency is concerned with the best possible utilisation of the community's scarce financial resources so as to attain the maximum benefit for the society. There are two broad ways to promote economic welfare in a world of scarcity: (a) prioritise the projects in order of social benefits and allocate the resources accordingly until the resources are exhausted, and (b) meet each obligation with the least possible amount of resources.

News: The Daily Financial Express/Bangladesh/19-Nov-12