ch 28 islamic finance
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Chapter 28
Islamic Finance
Holy Quran SunnaShariah - “Sacred Law”
Islamic Finance
Riba - UsuryInterest-based lending
where borrower repays more than amount borrowed to reflect
time delay in repayment
GhararExcessive uncertainty
and ambiguity about an outcome
Gambling and Insurance
HaramForbidden practices
No interestNo selling what you do
not ownNo selling of debts
Interest Prohibited
Profit and Loss SharingPermitted
Haram - Prohibited Interest
Halal - PermittedProfit and Loss Sharing
Avoid RibaNo interest elements
Null and void
Different cultures have different definitions of fairness and justice and
what is unfair and unjust
Islamic definition of fairness and justice
MoneyProfitRisk
Interest
Argument1. Can only charge rent on something that is a commodity
2. Therefore, it is unfair to charge rent on something that is not a commodity
3. Money is not a commodity.
4. Therefore money cannot be rented
5. Rent on money is called interest
6. Therefore cannot charge interest
Avoid Gharar
Gambling - Zero Sum Game
Seller should own what they intend to sell
Objectives
Maximize profit and wealth
Spread prosperity
Islamic FinanceMoney does not have
intrinsic value
Just a measure of value or medium of exchange
Islamic FinanceMust have an asset
involved in the exchange
No money for money
Participatory-type finance
Share profit and lossShare risk
Equity positionDebt position
Zakat - Religious Tax
2.5 Percent on profits
Poor, orphans, charityFinance projects
Operations
IslamicShariah - Interpreted
Non-IslamicSecular - Elected
Interest ChargingIslamic
Not allowedProfit and loss sharing
Non-IslamicAllowed
Fixed and variable
Interest on DepositsIslamic
Not allowedMay share in profits
Non-IslamicAllowed
Interest plus principal
Risk Sharing
IslamicMust share risk
Non-IslamicMay share risk
Penalty on Default
IslamicNot allowed to charge
Non-IslamicMay charge
Gharar
IslamicForbidden
Non-IslamicAllowed
Customer Relationship
IslamicPartner and Investor
Non-IslamicCreditor and Debtor
Shariah Supervision
IslamicRequires Board
Non-IslamicNo Board
Islamic Banks
Maximize shareholder wealth
Develop society
Source of Funds
ShareholdersDepositors
Deposits
Current Savings
Investment
Hiba
A non-predetermined return paid
Gift
Current Deposit Accounts
Receive funds on demandIssue checks
No guarantee of returnBank may give Hiba
Savings Deposit Accounts
WadiahMust get permission to
use for loans Bank may give Hiba
Investment Deposit AccountsMudarabah
Specific time periodProfit and loss sharing based
on predetermined ratioCould lose deposit
IslamicProfit and loss sharing system
Non Islamicinterest-based system
Equity Financing
Musharakah
Mudarabah
MusharakahPartnership
All contribute capitalProfit shared on prior agreement
Only lose invested capitalCharge a fee if manage
Project pays profit share to bankEntrepreneur pays bank capital
MudarabahPartnership
Bank contributes capitalEntrepreneur contributes work
Profit shared on prior agreementBank bears all capital losses
Asset Financing
Must own before reselling
MurabahahSalem
Ijarah Leasing
Murabahah
Bank buys the assetResells to customer
Price includes cost plus markup profit
Full disclosure transparencyCustomer pays installments or lump
sum at the end
SalemBank buys the asset today for
delivery in the future
Agriculture
Buyer responsible for delivery
Ijarah LeasingUsufruct: temporary use and enjoyment
of a property
Bank (Lessor) buys the asset and rents to client (lessee)
Client may return or receive asset at the end of the term
Sukuk - Islamic BondsRegular bonds not permitted
Interest and reselling debt prohibitedInvestor owns a proportionate
undivided share of the asset
Ownership equity position not a debt position
No guarantee or fixed return
Takaful - Islamic InsuranceDistribute losses among participants
Participants pool fundsNo insurer-insured relationship
Operator manages account fundParticipants pay premiums to create fund
Operator pays damages out of funds
Operator can charge an administrative fee
FutureDifferent views and interpretations
EvolvingNo uniform consensus
Four schools of thoughtShafi’i, Maliki, Hanafi, and Hanbali
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