Islamic Law and Financial Transactions Under It - Dissertation Example

?Introduction In the recent years, the socio-economic dynamics of nations across the globe has been hit hard by the recessive trend in the economy. The financial risks of the people and corporate sectors have considerably increased and therefore necessitate urgent measures to address the issue of global financing structure. In the changing format of globalization and technology, the complex structure of international, national and regional economics and finance has become a major challenge for the global entities. The traditional model of financial institutions needs to incorporate wider interests of emerging new pluralistic society. The paper would therefore be analysing the role of Islamic finance in the fast transforming environment of global economy with the view that it has brought in more radical but ethical paradigms within financial system of contemporary times. Historical background The Ottoman Empire in the pre WWI era has perhaps been the most prominent exponent of using tenets of Islamic finance in their trade and business transactions. The close trade relationship with their European counterparts, Islamic finance was closely aligned with that of European financial system. The system worked on the basis of sharing of profit and loss (Chachi, 2005). But post WWI and WWII brought into focus the divergent ideologies of two financial system into sharp focus. While the western economy and financial system was based on interest bearing instruments, Islamic finance was rigidly guided by the religious tenets of Islam which forbids transactions based on interests or gains made through unethical means (Ahmad, 1972)). In the contemporary times, Islamic finance has seen unprecedented growth primarily because of its fundamental principles based on Shariah guidelines (Anwar, 2008; Sundararajan & Errico, 2002). Principles of Islamic law and financial transactions under it Islamic finance is based on Islamic law that conforms to the Shariah guidelines of ethical practices in personal and business arena. Thus, Shariah can broadly be referred as Islamic law that defines the duties of man and the way they should be carried out (Vogel & Hayes, 1998; Hasanuzzaman, 1997). Shariah is part of Quran, the religious scripture of Muslims and is written in Arabic language. The interpretation of Shariah scholars therefore, may differ but the fundamental principle of ethics remains same. But Hadith, qiyas, idjma and fatwas are also key sources which inspire the ethical and moral considerations within the business transactions in Islamic finance (El-Gamal, 2006; Shahrukh, 1997; Pryor, 1985). Shariah principles are based on equity and prohibit financial transactions and activities that incorporate gharar (uncertainty), maiser (gambling) and riba (interest income) (Thomas, 2005; Nienhaus, 1986; Hasanuzzaman, 1994). The shariah compliance is vital element of Islamic finance products. Interestingly in the current times of highly sensitive global market, Islamic finance offers huge incentives in terms of ethically delivered financial instruments in myriad areas of finance (Venardos, 2005; Cooper, 1997; Ariff, 1988). It has made forays into banking, market risks and credit, insurance, liquidity management etc. and is fast emerging as credible alternative investment forum. Main Sharia compliant transaction structure and how they are used in practice All Islamic financial institutions are distinct in their constitution of board that comprises of financial experts and shariah scholars who evaluate the validity of financial instruments as per shariah principles. It uses various financial structures that conform to shariah but at the same time, adequately meet the needs of people in the contemporary times (Hasanuzzaman, 1971; Saeed, 1995). Some of those financial methodologies can be defined as under: Zakah: It is vital instrument that promotes social justice by ensuring that people who own more than nisab (basic need) must make donation of 2.5% of their yearly assets. The social funds are used to meet the needs of the poor. Murabaha: This financial instrument is mainly used for financing working capital and liquidity to the business. The institution buys the commodity from the business rather than lending the capital and thereby reduces the risk to the company or individual. It sells the same to the customer as predetermined cost. The long term investments vis-a-vis real estate are made through Istisna where products are sold prior to the production. Ljara: These are used for leasing purpose where products like heavy equipments and property are leased to the prospective borrower for specified rent and period. Mudarabah: It works as fund for business where capital is provided by one party and business operations are carried out by others. Interestingly while profit is shared, loss is solely borne by the capital funding agency or individual. Musharakah: It is based on partnership concept and share is distributed as per the contribution of finance. The profit and loss are equally shared. This type of instrument is mostly used in large projects where large equity is needed. In recent times, diminishing musharakah has become quite common. It is a hybrid financing technique that comprises of ljara and musharakah. The major feature are its variable rate of return and good credit profile which makes it attractive for new customers coming from Islamic and non Islamic sector. Sukuk: This is one of the most popular instruments of Islamic finance that raised capital through investment bonds known as sukuk. Sukuk is part of well defined pool of assets which gives good return and income that is passed on to the investor. Takaful: It is alternative to traditional insurance. The basic tenets of Islamic laws are used to insure people against financial risks. The main distinction lies in its methodology that relies on contribution of individual to common pool which can be used in crisis (Clarke, 2005; Al Habshi & Syed, 1997; Ali, 1989). The family becomes main beneficiary during crisis situation. It spreads the risks and considerably reduces financial loss to individual. Use of Islamic financial products in real life The various instruments of Islamic finance have increasingly become popular amongst Muslim community across the globe. Islamic insurance or takaful, sukuk bonds etc are important financial products in Islamic financial system that become highly relevant for common man (Divanna & Shreih, 2009; Ayman, 2004 Mirza, 1997). It is especially true for poor and under privileged segment of society that is not financially equipped to safeguard its interests against financial risks. Hence Islamic financial products are increasing used for making investment in real estate, capital market and insurance of life and property. Pros and con of Islamic finance products and conventional financial products Islamic financial products are based equity and fair practices. The role of shariah principles promotes ethics and moral imperatives within its operations and provides it with wide scope of credibility and accountability. In recent times, various financial scams like Enron, worldcom have brought forth the inadequacies within the financial system. Islamic financial system is based on non interest format and stringently conforms to shariah principles of fair practices. Thus, various Islamic financial products like sukuk, takaful, diminishing mudarabah, murabah etc have become attractive proposition for Islamic and non Islamic institutions. The western financial institutions like HSBC have already incorporated tenets of Islamic finance within their operation so as to attract the untapped potential of Muslim population. The major flaw in some of the Islamic financial instruments like mudarabah and musharakah is that there is ambiguity in the ownership. Also the loss is mostly borne by the party that funds the project which makes it difficult for people to invest in new ventures. Current challenges for Islamic financial products and future development The current challenges faced by the Islamic financial institutions are largely based on licensing in non Islamic nations. The various products are shariah compliant and therefore, non Islamic financial institutions are not able to adopt Islamic financial products within their operations. The massive changes required within their business strategies have become critical obstacles. The interest free principle of Islamic financial products does not give leeway for tax exemption that further adds complication for financial institutions to use its products (Lovells, 2004). But the most important and perhaps the key issue that makes Islamic finance highly desirable is its ethical guidelines which are highly pro-investors. In the current times, the vast disparity in income and also the interests of various stakeholders in the business makes it attractive proposition for the business world (Hassan & Rasem, 2009; Ahmad, 2009). The vast potential of Islamic countries for new businesses is also a huge incentive for non Islamic institutions to adopt Islamic financial system. Conclusion UK has become global centre for Islamic finance and is the first country to grant license to Islamic bank in London. Islamic Bank of Britain was formally launched in 2004 which has open floodgate of opportunities in the non Islamic countries across the globe. David Oakley (2010) asserts that assets of Islamic finance have increased to $822 billion in 2009 which is an incredible rise of 29% against previous year. Indeed, fast expanding chain of Islamic financial institutions across the geographical boundaries have heralded a new dawn for financial industry in the contemporary era of fast transforming socio-economic dynamics. One can therefore conclusively state that tenets of Islamic financial system are redefining the conventional financing. (words: 1500) Reference Ahmad, Mahmud. (1972). Economics of Islam: A Comparative Study. Lahore: Muhammad Ashraf Publications. Ahmed, H. (2009). Financial crisis, risks and lessons for Islamic finance. 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