Islamic Finance - PowerPoint Presentation Example

?Islamic Finance Introduction Islam is a blessing to man from Allah, and it is the complete way of life. That also includes how we conduct our financial dealings. The Islamic economic system revolves around core principles which structure and develops a robust business cycle. Among those principles is the prohibition of Riba’ (interest) as it is a curse on society. Riba’ only increases a man’s lust for wealth and it is this very greed that leads man into oblivion. The current financial crisis is a result of system structured on interest rates and related products. Instead Islam asks for an equitable distribution of wealth so that all members of society can prosper together. Concentration of wealth in a few hands is not desirable. Islam strikes a balance between conventional socialism and capitalism. One allows only for private ownership, while the other negates it outright. It is the Islamic way that has sought a path between the two extremes for the betterment of man. Unlike conventional systems, Islam recognizes only 3 factors of production which include capital, land and labor. The returns generated from the combination of these three are distributed accordingly. Capital gains return in the form of profits, land in the form of rent and labor in the form of wages. Islamic Contracts Islamic contracts govern the business conventions on how trade transactions must be entered into. First of all, the trade must be permissible in the light of Shariah. It cannot contain any element of Riba’, Gharar, Mysur, Haram etc. Secondly, there are many conditions which must be fulfilled in order for a contract to be rendered valid. They include: A condition which is not against the contract is a valid condition A condition which seems to be against the contract, but is normal market practice, is no void unless proved in the light of Shariah. A condition which seems to be against the contract and not market practice but favors any one participant is void. A condition which is against the contract, not market practice, and doesn’t favor anyone is a void condition. Sales in Islamic Finance The concept of sales in Islam is the exchange of a thing of value with another thing of value. However, it is very strict on the core principles of sales. In the contract, there must be offer and acceptance for the contract to be executed. Furthermore, the individuals must be sane and of proper age to enter into agreements such as this one. The commodity/asset under consideration must exist. It must also have some intrinsic value to as to cater to the sale. Furthermore, it should be capable of showing ownership. For example, no one can point to the moon and claim that they own it. It exists, and must have some value. But since it cannot be owned, it cannot be transacted. Furthermore, the asset must be deliverable to the buyer, the quantity and quality must be aforementioned. The price of the trade must be addressed at the start so as to avoid any misunderstandings between the parties. Lastly, either physical or constructive possession of the asset must be taken in order to render the sale complete. Modes of Islamic Finance The modes of Islamic Finance, while seemingly like their conventional counterparts, are free from all the Haram (unlawful) ways which have been prohibited in Islam. Following are the types of Islamic Financing: 1. Musharakah In a Musharakah agreement, two parties come together to form an alliance for commercial enterprise and share the profits according to a set ratio. This is decided at the time of entering into the alliance. However, if a loss occurs then the parties distribute that according to the rate of participation of initial investment from each individual. There are two explicit types of Musharakah. In the first type, the partnership arises out of a joint ownership of an asset. For example, two brothers inherit their father’s sugarcane factory. Hence they become partners through the joint ownership which exists. The second kind is via contracts. In this case, the two individuals enter into an agreement of the above-mentioned process. Taqi Usmani has differentiated between conventional financier arrangement and Musharakah agreements, citing that in a Musharakah arrangement, there is no fixed rate of earning. Rather the actual profit gained is distributed amongst partners. Similarly, a loss is distributed according to the pro rata share of each partner. Conventional financiers face no risk of a loss. 2. Mudarabah A Mudarabah contract is a type of partnership agreement in which one of the partners provides the capital/funds for the enterprise. The other partner takes responsibility for the management of the enterprise. Both of them decide before hand the profit distribution rate. The fund provider is called the Rab-ul-Maal while the individual responsible for the management of the business is referred to as the Mudarib. Again there is a classification in Mudarabah, based on whether the Rab-Ul-Maal specifies which industry to invest in, or leaves it as an open playing field for the Mudarib. 3. Murabaha Moving on to Murabaha Sales, this particular type of transaction includes the disclosure of the cost of the commodity and the profit added to it. Murabaha transactions are primarily used in Islamic banks as a mode of lending funds to other banks/retails clients. It differs from the Islamic term Musawamah. Musawamah is purely a sale of a good with only the disclosure of a sales price. The cost of the good under consideration is not given. Hence, this is the demarcation between a Musawamah and a Murabaha transaction. 4. Istijar Another mode of finance in Islam is Istijar. This is a unique arrangement between parties whereby a master agreement is signed between them. This master agreement governs the whole arrangement, including quality, quantity etc. Thus, this type of arrangement eliminates the need for an offer and acceptance over and over again. Furthermore, there is no room for bargaining once the master agreement is in effect as both parties enter into it with mutual consent. There are two categorizations of Istijar. In the first category, the price is determined after all the transactions have taken place. The flip side is that price is determined at the start, but is taken up at each interval when the good is purchased. 5. Ijarah Ijarah is one of the most widely used modes of financing in Islamic Banks. Ijarah refers to the leasing of something on a rental basis. As a form of Islamic lease, Ijarah rules out the interest factor in loan agreements, rather charging a rent for the asset which the bank owns. The most common use is seen in auto financing through Ijarah mode. 6. Salam The Salam transaction is referred to a deferred payment transaction. In this mode of finance, an individual expecting the delivery of goods at a future date enters into a salam transaction whereby he takes full payment of that good in spot value from a bank, and in return gives the entitlement of that good to the bank. The condition of Salam is that the price must be paid in full today, and it must be on spot. The idea of a Salam transaction is to provide immediate cash flow ease to individuals such as farmers who pledge it against their crops etc. 7. Istisna Lastly, Istisna is a form of Islamic transaction in which a good which has yet to be manufactured is transacted. This is evident in the case of large manufacturing orders/goods which are only produced on order. Conclusion The global growth of Islamic finance stayed strong in 2009, just when the majority of the world's financial systems found themselves deleveraging amid the capital market dislocation and its spread to economies around the world. Islamic finance is on the rise, and there is still huge potential in this market. The only thing that is needed is the creation of awareness amongst the common masses. Once that happens, Islamic finance/banking will soar to new heights. However having said that, M. Raquibuz Zaman and Hormoz Movassaghi make a very keen observation in their article Interest Free Islamic Banking: Ideals and Realities that “The use of financial instruments that bear a striking resemblance to interest-based instruments but are called “profit/loss" sharing is a deception that the IBs can live without.” Thus it implies that Islamic Banking should not focus on emanating the products of conventional banks, but rather focus on the products which are genuinely Islamic based and can offer riba free banking solutions. References Usmani, T. “The concept of Musharakah and Its Application as an Islamic Method of Financing” Arab Law Quarterly, Vol.14 no 3 pp 203-220. 1999. Web. 16 March 2011. Zaman, M. R. and Movassaghi, H. Interest Free Islamic Banking: Ideals and Reality, The International Journal of Finance, Vol 14 No 4. 2002. Web. 16 March 2011. Read More