The Comparison of Islamic Financial Activities with Normal Financial Activities - Term Paper Example

ISLAMIC FINANCE Introduction “Most readers encounter Islamic finance first through grossly simplistic ments such as Islam forbids interest” (El-Gamal, 2008, p.2). A layman cannot understand the essence of Islamic fiancé unless he learn about it deeply. Islamic religion has specific norms for most of the activities in human life. Even the banking or financial activities are defined in a peculiar manner by the Islamic religion. Shariah or the Islamic law have its own interpretations for the economic and financial activities. Shariah prohibits people or financial institutions like banks from accepting any fees as interest for the money lent by them. Ijarah or leasing, Islamic funds, Sukuk or the Islamic bonds, and the Takaful or the Islamic insurance; all are different from the conventional leasing, funds, bonds and insurance methods prevailing in other parts of the world. This paper compares the above mentioned Islamic financial activities with normal financial activities. Ijarah and conventional leasing Conventional leasing is a contract in which asset is transfers to users for an agreed period on an agreed consideration. It is not necessary that a person have to own a property in order to enjoy benefit of it in conventional leasing. Ijarah on the other hand is a lease contract as well as a hire contract (Leasing or Ijara, n. d). In conventional leasing, the lesser will give his property or equipments to the lessee for an agreed period of time on a monthly or annual rental basis. The lesser will not have any claim on the profit earned by the lessee. The lessee should pay the agreed amount monthly or annually to the lesser irrespective of he achieves profits or loss. In conventional leasing the ownership of the property or equipment leased would be transferred to the lessee till the end of the leasing period. The lessee should do all the maintenance and repairs needed for the property during the leasing period. On the other hand, Ijarah refers to the transfer of usufruct of asset against the payment of rent (Ayub, 2008, p.79). The term ‘Usufruct’ means the legal right to use and derive profit from a property that belongs to another person, as long as the property is not damaged. Ijarah is a totally different transaction in which the ownership of the leased asset does not transfer (Ayub, 2008, p.48). The ownership of the leased property in Ijarah would belong to the lesser always even though the lessee is making profit out of it. In case of any debt created by trade or Ijarah transactions, banks are not allowed to charge anything over and above the principal amount (Ayub, 2008, p.75). Only the principal amount is guaranteed to the lesser in Ijarah transaction even if the debt of the lessee is more than the principal amount. Ijarah advocates the affordable instalment procedures in purchasing activities. In other words, Ijarah is worked on humanitarian principles and it does not like to impose heavy burdens on the lessee. On the other hand in traditional leasing the such humanitarian considerations will not be there and the lessee should pay the agreed amount to the lesser even if he losses in his business using the property of the lesser. Ijarah is the most suitable in mean to raise investment funds to industries where rapid technological innovation is taking place. The major advantage of Ijarah over conventional leasing is that the asset remains with the lesser always (Leasing or Ijara, n. d). Shariah issues on trading stocks and different types of Islamic funds Islam never prohibits anybody from investing in stocks provided the investor obeys certain rules of the Shariah. The earnings obtained from the stock investment will be considered as halal or legitimate only if the investor invests in a halal company. Shariah laws believe that when an investor invests in a company stock, he is becoming the part of the company. The investors should have clear idea about the activities of the company and they should make sure that the company is legitimate in all means. In other words, investing in illegal or illegitimate companies is prohibited by the Shariah laws. The investor should make sure that the company he invests does not make any income from interests. However looking at the current situation shariah scholars have permitted to invest in stocks of companies whose income from interest forms less than 5% of a company’s total income. Some scholars have fixed that ceiling at 10% of a company’s total income (Khaled, 2006) Margin trading is also prohibited by the Shariah laws since in most cases the money used for margin trading is loaned from the broker, for which interest needed to be paid. From shariah point of view you cannot sell what you do not posses and hence short selling is also prohibited as per the Sharah laws (Khaled, 2006). Shareholders of joint stock companies cannot terminate their share holding. They can simply transfer their part through the sale of their shares in the market (Ayub, 2008, p.120) Equity funds, real estate funds, hedge funds etc are some of the examples of Islamic funds. “The first Islamic equity fund was the Amana Income Fund*, established in June 1986 by members of the North American Islamic Trust (NAIT), an organization based in Indiana which oversees the funding of mosques in America among other things. Mendaki Growth Fund, Singapore (5/91), Southern Pure Specialist Fund, South Africa (6/92), Al Rajhi Local Share Fund, Saudi Arabia (7/92),Tabung Ittikal Arab-Malaysian, Malaysia (1/93) etc are some of the major funds came into exist in the 1990’s (Al-Rifai, 1999, p.1). Sukuk and conventional bonds Sukuk is a financial certificate in Islamic finance just like a conventional bond. Since Islam prohibits the earning through interests, Sukuk bonds are different from the conventional bonds. “In Sukuk an investor get returns on the basis of ownership rather than the interests” (Ayub, 2008, p.193). Sukuk offers fixed returns to the investors whereas same thing cannot be said about the conventional bonds. Conventional bonds are always depends on the market trends. Sukuk invest in assets whereas traditional bonds invest in currencies. The return from assets may be in the form of rent in Sukuk investment. Sukuk can be used to realise the huge potential of Islamic finance (Ayub, 2008, p.19). Even though many people criticizes Sukuk like Islamic financial activities, many other institutions at present trying to implement it not only in Islamic world, but in other parts of the world as well. Islamic banks may sell and purchase Shariah compliant money and capital market instruments like stocks and Sukuk (Ayub, 2008, p.192) The claims involved in Sukuk bonds are not limited to cash flow alone as in conventional bonds, but it can claim the ownership as well. “The most common Sukuk structure involves selling property and leasing it back” (El-Gamal, 2008, p.35). “Property developer Nakheel said on Monday it will meet its 2009 Islamic bond obligations in the next 14 days, averting default after the Abu Dhabi government stepped in with a bailout” (Nakheel says to honor 2009 sukuk in next 14 days, 2009). Nakheel was in trouble recently and it created immense fears among the investors because of the recent Dubai crisis. But Abu Dhabi stepped in for helping the Dubai world and Nakheel which helped them to overcome the current crisis. Saudi-based Islamic Development Bank (IDB) plans to issue Islamic bonds (sukuk), in the first half of 2010 worth around $850 million, a senior official said on Thursday. In September IDB, the Saudi based triple-A lender, which funds projects in Muslim member countries, sold the first tranche of a $1.5 billion sukuk, a $850 million sukuk which was priced at 40 basis points over mid-swaps (Sukuk.me: Saudi IDB eyes $850m sukuk, 2009). Takaful and conventional insurance Takaful is an alternative to conventional insurance in Islamic finance (Ayub, 2008, p. 68). As in the case of other financial activities mentioned above, insurance activities are also have special characteristics in Islamic fiancé. Takaful obeys the Islamic laws and it was come into existence Islamic community, more than thousand years before. Co-operation or the shared responsibility is the core of Takaful. Takaful policy holders have better cooperation in between them for the common good. Takaful policy holders pay their subscription to assist others who are in need. Losses and liabilities of all the policy holders of Takaful will be divided equally among the policy holders. In short Takaful is a form of insurance based on cooperation. Conventional insurance don’t have any such cooperation motto mentioned above. It is mainly for the protection of the policy holder in case of unexpected accidents, sick, loss of property or death. Policy holders may not have any responsibility to help each other. “The current Takaful practice uses a combination of two types of ‘Aqad (contract). These are the Tabarru (donation) and Mudharabah (investment) contracts which are free from the elements of Riba (interest), Maisir (gambling) and Gharar (uncertainty)” (Takaful, 2007). The major challenges faced by Takaful are; Takaful products are more expensive compared to traditional insurance products; nonexistence or retakaful arrangements in the market; lack of product flexibility in terms and conditions; hidden agendas; unattractive investment programmes etc (Takaful industry: Global challenges and opportunities, n. d, p.3) Conclusions Islamic financial products and institutions are totally different from the traditional financial products and institutions. Islamic financial transactions are totally based on the Shariah laws whereas the traditional financial products may not have such barriers. Islamic financial products are gradually acquiring more popularity in the current world even outside Islamic communities because of the failures of some of the traditional financial institutions and their products. References 1. Al-Rifai Tariq, (1999), Islamic Equity Funds, Retrieved 22 December 2009 from http://www.kantakji.com/fiqh/Files/Markets/30031.pdf 2. Ayub Muhammad (2008), Understanding Islamic Finance, Publisher: Wiley (January 2, 2008) http://www.amazon.com/Understanding-Islamic-Finance-Wiley/dp/0470030690/ref=sr_1_1?ie=UTF8&qid=1261463428&sr=8-1-fkmr1#noop 3. El-Gamal Mahmoud A. (2008), Islamic Finance: Law, Economics, and Practice Publisher: Cambridge University Press; 1 edition (November 24, 2008) http://www.amazon.com/Islamic-Finance-Law-Economics-Practice/dp/0521741262/ref=sr_1_1?ie=UTF8&s=books&qid=1261465272&sr=8-1 4. Khaled, (2006), Investing in stock market: the Shariah way, Retrieved 22 December 2009 from http://islamicinvesting.wordpress.com/2006/07/03/investing-in-stock-market-the-shariah-way/ 5. Leasing or Ijara, (n. d), Retrieved 22 December 2009 from http://www.scribd.com/doc/11796388/11Leasing-or-Ijara 6. Nakheel says to honour 2009 sukuk in next 14 days, (2009), Retrieved 22 December 2009 from http://www.sukuk.me/news/articles/72/Nakheel-says-to-honor-2009-sukuk-in-next-14-days.html 7. Sukuk.me: Saudi IDB eyes $850m sukuk, (2009), Retrieved 22 December 2009 from http://www.sukuk.me/news/articles/72/Sukukme-Saudi-IDB-eyes-$850m-sukuk.html 8. Takaful, (2007), Retrieved 22 December 2009 from https://www.ism.net.my/Takaful/tabid/94/Default.aspx 9. Takaful industry: Global challenges and opportunities, (n. d), Retrieved 22 December 2009 from http://www.fwugroup.com/images/upload/Euromoney-12.05.pdf Read More