The basics of Islamic finance principles

Published June 27th, 2016 - 11:43 GMT
Saudi Arabia's IPO drive and platforms provided through Dubai Islamic Financial Centre and Nasdaq Dubai are significantly promoting the Islamic Capital Market towards its $10 trillion target. (File photo)
Saudi Arabia's IPO drive and platforms provided through Dubai Islamic Financial Centre and Nasdaq Dubai are significantly promoting the Islamic Capital Market towards its $10 trillion target. (File photo)

It can be wondering into the context of ancient principals of Islamic finance yet it is the evident fact that Islamic Financial Concepts are thriving in the modern age with the fastest growing rate among the capital markets.

In the presence of modern financial system that is primarily based on interest and probability, the Islamic financial system excludes interest and uncertainties yet meets the common goal in achieving the same economic benefits as conventional finance offers to the society. Having the roots in past, Islamic finance links present with the fact that is based on principals and features that were established more than 1400 years ago.

Islam teaches the mankind to fulfil obligations, to be accountable, to record in writing if a credit transaction arises between contracting parties, to observe proper measurement and not to commit fraud.

The history of Islamic commerce begins with the revelation of holy Quran and Sunnah of the Holy Prophet Muhammad (peace be upon him) that contains legal principals and injections dealing with subjects such as ritual, marriage, divorce, succession, commercial transactions and penal laws. It is a believe held by religion that absolute ownership belongs to Almighty Allah and man as servant and vicegerent act in trust in administering wealth in a just and equitable manner. The payment of Zakat is the third pillar of Islam and is obligatory for those who have met the prescribed monetary and wealth in due law for every lunar period.

In advocating the form of economic activities under Islam, trade is encouraged, usury is prohibited, and acquisition of wealth should be achieved through lawful means that promote mutual consent and goodwill. It is termed as Shariah-compliance, to ensure that the financial activities of the institution meet the requirements of Shariah Principals and rules prescribed in the Quran and the traditions of the Prophet Muhammad (peace be upon him). Presently there are the prescribed forms of standards, guidelines and best practices by governing bodies such as AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions), IFSB (Islamic Financial Services Board) and followed by Internal Shariah Control Systems (ISCS).

It is historically evident that Muslim civilisation adopted a comprehensive accounting, reporting and auditing system since AD624 that applied a form of double-entry book keeping as globally accepted as on date. This in particular is evident from the documented works of two Muslim scholars, Al Khawarizmy and Al Mazendarany in AD976.

A complete system of life is generally based on moral, good conduct and legal prescriptions. Shariah provides guidance in terms of believe, moral conduct and practical rulings or laws wherein moral values have been incorporated as legal requirements in some specific contracts such as Amanah (honesty) in Murbahah (markup) financing.

For example the principals of moral values pertaining to commercial transactions must include :

1. Timeliness of payment of debt or delivery of an asset,

2. Tolerance in terms bargaining by considering each other's requirements and circumstances,

3. Mutual revocation of a contact on request of one party, if finds uncomfortable.

4. Honesty or Amanah in all statements, representations and warranties.

5. Uncertainty (Gharar) and interest (Riba) are prohibited by Shariah.

In the present age Islamic finance is a multinational and multi-disciplinary emerging industry, the size of Islamic finance market is estimated up to $2 trillion and projected to grow to $3 trillion until 2018. The Islamic finance assets represents one per cent of the global financial market. The sukuk issuance is accelerating the Islamic Capital markets at the annual growth of 21 per cent. Not only the Middle East and South Asian countries but also the non-traditional geographies such as Africa, East Asia and Americas are emerging for the industry been recognised over the period of last 40 years.

Saudi Arabia's IPO drive and platforms provided through Dubai Islamic Financial Centre and Nasdaq Dubai are significantly promoting the Islamic Capital Market towards $10 trillion target.

It is a fast growing industry that is presently having most of the identical products like conventional or western banking i.e. Islamic Private Equity Funds, Islamic leasing and ETFs, Islamic Fixed Income - sukuks and Islamic derivatives or structured products. In addition to the insurance based Takaful products and services the Islamic Capital markets are also growing towards Islamic Forward Forex, options and profit rate Swaps.

Though the products are meeting the modern requirement of the industry yet the unique features of Islamic banking or Shariah compliance are remaining same as summarised follows:

a) Interest (Riba) is prohibited in all its forms, be it cash or kind. Gifts for prospective savings on Wadiah (safekeeping), Qard/Hassan (loan) are also deemed to be promising a form of interest in kind, are not permissible.

b) All banking business on sale or lease must have an underlying asset that is contrast to the conventional banking where the asset element is not necessary.

c) All transactions made by Islamic Financial Institutions must be free from elements of uncertainty (Gharar) and gambling (Maisir).

d) Concept of profit and loss sharing is peculiar to Islamic banking although, strictly speaking, Islamic banking is not an equity market, which is normally represented by the stock market.

e) An Islamic bank is neither a lender nor a borrower, but can instead become a bonafide trader licensed under banking law.

f) A financial institution must have Shariah Board and Committee to be termed as Islamic Financial Institution.

g) Islamic Finance must not be involved in any activities pertaining to prohibited goods or services by Islam i.e. Non-Halal foods, intoxicating drinks, entertainment and pornography, tobacco-related products and weapons.

h) Overriding principles of Islamic law is Shariah-compliant.

By Sahitya K. Chaturvedi

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