Session 1. Overview of Islamic Finance

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1 Session 1 Overview of Islamic Finance 1

2 Islam is a way of Life There are rules governing the many facets and aspects of life. AQIDAH (Faith & Beliefs) SHARIAH (Practices & Activities) AKHLAK (Moral & Ethics) IBADAH (Worship) (Man - MUAMALAT (Human Interactions) Political Activities Economics Social Banking & Financial Activities 2

3 Islamic Finance Islamic Finance revolves around activities carried out in ways that do not conflict with the conscience of Man and Islam. It represents an assertion of religious law in the capital market transactions where financing transactions should be free from the involvement of prohibited activities by Islam as well as free from the elements such as : Riba Maisir Gharar 3

4 Objective of Islamic Banking Non-Involvement in Haram Activities To Provide Transactions Free from Riba, Gharar and Maisir To Provide an Alternative Financing to the Conventional Financing To Provide for a More Equitable Financial System To Mobilise Muslim Funds Efficiently & Effectively Create Viable Islamic Assets 4

5 Financial Transactions In Islam Granting of Money in Islamic Finance Arises From: Partnership ventures Contracts of Exchange Lease Fee-based financial services 5

6 Holistic Approach in Islamic Finance Sources of Funds are from Permissible Activities and Applied Toward Permissible Activities Takes the Role of a Trader Financing is Backed by Real Assets Real Asset-Owners in the case of Ijarah Pricing is based on True Market-Based Mark-Up or Service Rate No Penalty Interest 6

7 Core Prohibitions in Islamic Finance Riba Gharar Maisir Haram Activities 7

8 Time Value of Money Time value of money has a place in Islamic Finance. The return available to an individual saver, need not relate to an interest of riba-based transaction. The return available on the next best permissible investment (from trade of otherwise) constitutes time value of money in Islamic Finance. 8

9 Gharar Gharar is the lack of information disclosure, uncertainty, ambiguity, and the presence of excessive risks. 9

10 Maisir Maisir can be defined as gambling i.e. games of chance often involving money or belongings. One More on my side 10

11 Non-Halal Activities Financial services based on Riba; Gambling and gaming; Manufacture or sale of non-halal products or related products; Conventional insurance; Entertainment activities that are non-permissible according to Shariah; Manufacture or sale of tobacco-based products or related products; Stockbroking or share trading in Shariah-non compliant securities 11

Pre-Islamic Mode of Financing Musyarakah Pre Islamic Trading Mudharabah Ijarah Pre Islamic Coin Murabahah Istisna Salam Existed even before

12 Pre-Islamic Mode of Financing Musyarakah Pre Islamic Trading Mudharabah Ijarah Pre Islamic Coin Murabahah Istisna Salam Existed even before the coming of the Holy Prophet Muhammad The Prophet himself practised Mudharabah The Prophet endorsed these facilities as acceptable in Islam 12

13 The Rise in Usury It was mostly illegal in Christian medieval Europe to charge interest on a loan of money, for much the same reasons Islamic law forbids it: That, as money is intrinsically unproductive, it is ethically wrong to make money from money. In Central Europe, those who sought to borrow (interest-based) had to resort to illegitimate borrowing. The rise in acceptance of usury began to the time of King Henry VIII when he broke ranks from Rome. Free from Rome s oversight, the influence of the Church over the State waned. Within two centuries, usury had taken prominence. Interest- based lending became acceptable. England was the birthplace of formal conventional banking 13

14 Islamic Finance Revival The revival of Islamic Finance was mainly fuelled by the (1) Independence after WW II (2) Iran Islamic Revolution (3) new wealth of the Arab Nations arising from the discovery of oil 14

15 Evolution of Malaysia s Islamic Finance Lembaga Tabung Haji A successful Islamic savings Institution, albeit set with an objective of enabling depositors to perform their Haj Bank Islam Malaysia s first Islamic Bank Incorporated in 1983 under the Islamic Banking Act 1983 Syarikat Takaful Malaysia Malaysia s first Takaful Operator Incorporated in 1984 under the Takaful Act 1984 Sukuk Market First issuance in

16 Evolution of Islamic Capital Markets 1990 Issuance of Bai Bithaman Ajil Islamic Bonds by Shell MDS 1994 Issuance of Ittikal Fund an Islamic Unit Trusts by AmInvestment Malaysia s first full fledge Islamic stock broking company 2002 The first Global Sukuk by Guthrie - $US395 Million Sukuk Ijarah The first Sovereign Global Sukuk by Malaysia - $US600 Million Sukuk Ijarah 2006 In 2006 MIFC as a one stop Islamic Financial Centre 16

17 Session II Shariah Commercial Contracts 17

18 Sources of Shariah Quran Sunnah Ijma Qiyas 18

19 The Quran The Book of Revelation and Last Testament Contains divine guidance and direction for mankind 19

20 Sunnah The Sunnah is the living example of Prophet Muhammad the practical example of the implementation of the Qur'anic guidance. 20

21 Ijma Is the consensus of Islamic scholars which is legally binding, in a given generation on particular points of Islamic Law 21

22 Qiyas Qiyas is the process of analogical reasoning from a known injunction to a new injunction. 22

23 QIYAS Conditions for Application Qiyas can be applied only when there is no solution to the matter in Quran or in the Hadith; Qiyas must not go against the principles of Islam; Qiyas must not go against the contents of Quran neither must it be in conflict with the traditions of the Prophet (pbuh); and It must be a strict Qiyas based on either Quran, Hadith or the Ijma. 23

24 Islamic Financing Contracts Contracts of Exchange Murabahah Bai Bithaman AJil Bai Innah Salaam Istisna Participatory Contracts Mudharabah Musharakah Lease Ijarah 24

25 MURABAHAH Cost Plus Sales PARTIES SELLER BUYER FINANCIER Most popular Islamic financing globally because the mechanics of the financing is widely accepted by Syariah scholars easy in terms of operations low risk and avoids liquidity problem by virtue of it being a short-term financing 25

26 MURABAHAH 1. Initiation a. Buyer requests Financier to finance purchase b. Settlement to Financier on deferred term c. Financier quotes order selling price (Cost + Mark-Up) Buyer Financier Seller 4. Buyer pays 2. Financier Pays Seller Financier Selling Price as per stipulated period 3. Seller deliver goods 26

27 BAI BITHAMAN AJIL 1. Initiation a. Buyer requests Financier to finance purchase of property b. Settlement to Financier on deferred installments c. Financier quotes order selling price (Cost + Mark-Up) Buyer Financier Developer 4. Buyer pays Financier Selling Price in Installments as stipulated 2. Financier Pays Developer 3. Developer hands over property 27

28 Murabahah and BBA Rules and application in Murabahah and BBA

29 BAI INNAH 1. Financier owns Merchandise 2. Financier sells Merchandise at RM X. Settlement to Financier on deferred terms Financier Borrower Merchandise 3.Buyer resells merchandise to Financier at RMX - RMY= RMZ Financier pays Borrower RM Z immediately. 4. Buyer pays Financier Selling Price as per stipulated period 29

30 BAI INAH Rules and application in Inah

31 BAI SALAM A contract for the sale of goods where delivery is made in the future. 31

32 BAI SALAM 1. Initiation a. Buyer requests Financier to finance order with future delivery b. Settlement to Financier on deferred term c. Financier quotes order selling price (Cost + Mark-Up) Buyer Financier Seller 4. Buyer pays Financier Selling Price as per stipulated period 2. Financier Pays Seller 3. Seller deliver goods at the pre-determined future date 32

33 BAI ISTISNA A contract for the sale of goods which skilled workman commits himself to manufacture for the buyer. Skilled Worker Contract of Sale Buyer 33

34 BAI ISTISNA 1. Initiation a. Buyer requests Financier to finance manufacturing order b. Settlement to Financier on deferred term c. Financier quotes manufacturing order selling price (Cost + Mark- Up) Buyer Financier Craftsman 4. Buyer pays Financier Selling Price as per stipulated period 2. Financier Pays Craftsman to enable to start work 3. Craftsman deliver goods upon completion 34

35 Salam and Istisna Rules and application in Salam and Istisna

36 IJARAH The right to use and derive benefit from a property with lease rental paid to the Owner 36

37 IJARAH 1. Owns Asset 4. Maintains upkeep of asset OWNER USUFRUCTUARY / LESSEE ASSETS 3. Lessee pays rental for usufruct 2. Assets leased to usufructuary 37

38 Ijarah Rules and application in Ijarah

39 Partnership - MUDHARABAH RABBUL MAL PARTIES MUDHARIB Provides capital, assets Entitled to profit according to pre-agreed ratio Bears loss of capital Entrepreneur-Trustee contributes to talent, expertise, skills or labour Holds in trust the capital Entitled to profit according to preagreed ratio Does not bear any liabilities arising from losses unless due to his negligence or breach in fiduciary duties 39

40 Partnership MUDHARABAH(cont.) MUDHARABAH RABBULMAL MUDHARIB CAPITAL SKILLS / LABOUR VENTURE PROFIT LOSS RIGHTS Pre- Agree Ratio Borne By Rabbulmal Pre-Determined 40

41 Partnership - Musharakah Where two or more persons contribute capital, assets or labour into the partnership. Partners enjoy similar rights Partners share profit in pre-agreed ratio. It is not necessary to share profit according to ratio of capital contribution. Losses shall be borne together. 41

42 Partnership MUSHARAKAH(cont.) MUSHARAKAH PARTNER PARTNER PARTNER CAPITAL OR LABOUR VENTURE PROFIT/ LOSS RIGHTS Pro-Rated or Equal Equal 42

MUSHARAKAH MUTANAQISAH 1. Initiation a. Buyer requests Financier to finance purchase of property b. Settlement to Financier on diminishing partnership basis c.

43 MUSHARAKAH MUTANAQISAH 1. Initiation a. Buyer requests Financier to finance purchase of property b. Settlement to Financier on diminishing partnership basis c. Financier quotes its Participatory Value Buyer Financier Developer 4. Buyer pays Financier 2. Financier Pays Developer Selling Price in Installments as stipulated 3. Developer hands over property 43

44 Mudarabah and Musharakah Rules and application in Mudarabah and Musharakah

45 Riba, Gharar and Maisir in Insurance Insurance A contract of buy and sell Based on the concept of guarantee by the insurer to the policy holder Premium belongs to insurer If amount of premium collected more than claims, insurer will make a profit If it is lesser, it will result in a loss

46 Riba, Gharar and Maisir in Insurance Riba Money in exchange for money In the event of claims, premium paid is not at par to the claims - riba Investment/savings in interest bearing instruments Fixed deposits Bonds Non-shariah approved investments

47 Riba, Gharar and Maisir in Insurance Gharar Uncertainty on The subject matter, in terms price»sale price; how much is the premium?»counter value; how much will be the claims paid? in terms of time (when claims will be paid?) The event of the insurable risk happening/not happening

48 Riba, Gharar and Maisir in Insurance Maisir Uncertainty that may lead to gambling characteristics; risk transfer is uncertain and based on chance Quick money on gambling of the risk covered Non-Shariah compliant contract of guarantee For a contract of guarantee, there should not be any charge It should be a benevolent act

49 Riba, Gharar and Maisir in Insurance Takaful Contract of tabarru (contribution); one sided and need not to have counter value Based on the concepts of guarantee to indemnify among participants Contribution belongs to the fund (not the takaful operator); participants are the beneficiaries of the fund Takaful operator acts as an agent for the participants and receives fee (based on contract of wakalah)

50 Wallahua lam Thank you

Challenges in Islamic Finance

Challenges in Islamic Finance Dr. Ahmet Sekreter Business and Management Department, Ishik University, Erbil, Iraq Email: ahmet.sekreter@ishik.edu.iq Abstract Doi:10.23918/icabep2018p29 The growth of Islamic