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Core Elements of Islamic Finance - Essay Example

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Islamic finance may be defined as a financial system whose operations are compliant to Islamic law, known as Sharia, and are directed by Islamic economics (Zepeda 19)…
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Download file to see previous pages This aims to ensure that the target and purpose of the Islamic finance industry benefit the society by balancing spiritual needs with material pursuits, as well as social and individual needs. This paper will discuss ways in which Islamic finance can be seen as an innovative way that could substantively redefine finance and also why it is substantively different from conventional finance. Core Elements of Islamic Finance Islamic finance is different from conventional banking and the core notion behind it is that God (Allah) owns all the wealth in the world, over which man is only a trustee. Humans, therefore, have an obligation to manage the wealth in accordance with the commands of Allah that prohibit activities which do not promote justice (Rammal & Zurbruegg 69). One major reason for imposing Islamic ethics and law on finance is to promote and uphold social justice, since Islam is deemed to be inseparable from social justice. Islamic finance is based on the core perspective that prohibits the practice of usury, which means lending money to earn interest, also known as riba. Sharia law defines it as an excess compensation that has no due consideration. Effectively, this underlying factor redefines finance from the Islam point of view. However, it does not expressly preclude an agreed-upon return on investment by the transacting parties, where any reference to interest only sets standards for the return on investment for transparency purposes. The implication is that interest is not used in the transaction, although capital is not just provided to investors without a return. This concept stems from the fact that Sharia law does not recognize money as having intrinsic value, but rather, only as a measure of value whose use should not be paid for. This makes Islamic finance an asset based industry, in contrast to the currency based conventional finance system, and investments are structured on the ownership or exchange of assets, with money only acting as a payment medium to effect transactions (Rammal & Zurbruegg 73). Innovations of Islamic Finance Islamic financial institutions have taken advantage of some of the misgivings of conventional finance and launched innovative initiatives that have supported their steady progress. Deficiencies have led people to seek alternatives and move away from the conventional system. The strong ethical orientation, on which Islamic finance is based, as well as the connection of the movement of Islamic finance with the modern resurgence of Islamic civilization, is appealing even to non-Muslims. Islamic finance has the potential to establish a closer link between financial and real segments of the economy. Innovative products like Musharakha and Mudaraba, which mean equity participation and partnership financing respectively, ensure profit sharing that is based upon partnership principles (Timur 791). Another Islamic view of finance is that it emphasizes on risk and profit sharing, rather than the notion of risk transfer as seen in conventional finance and banking. For example, the Murabaha product (which refers to a cost-plus sale) and other trade-based finance modes undertake trade with a mark-up and facilitate financing on short-term basis in a similar fashion to purchase finance in conventional finance. However, the difference is that a bank may buy an asset from a seller and agree on the ...Download file to see next pagesRead More
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