Islamic FinanceIslamic Finance

Hassan ElalfyHassan Elalfy

Chapter (1): Overview of Chapter (1): Overview of Contemporary Islamic FinanceContemporary Islamic Finance

The basic principles underlying Islamic financial The basic principles underlying Islamic financial transactions are:transactions are:

- The purpose of financing should not involve The purpose of financing should not involve an activity prohibited by Islamic law (an activity prohibited by Islamic law (Shari’aShari’a))

- The financing must not involve The financing must not involve ribariba (the (the giving or receiving interest)giving or receiving interest)

- The financing should avoid The financing should avoid gharargharar (uncertainty, risk, and speculation)(uncertainty, risk, and speculation)

- Islamic finance promotes the sharing of risk Islamic finance promotes the sharing of risk and reward between contracting parties and reward between contracting parties (Venture Capital)(Venture Capital)

Overview of Contemporary Overview of Contemporary Islamic FinanceIslamic Finance

Islamic financial principles is supported Islamic financial principles is supported by the fact that Islam permits the by the fact that Islam permits the accumulation of wealth as long as the accumulation of wealth as long as the source of wealth generation does not source of wealth generation does not breach the principles (that is, the breach the principles (that is, the activities are halal, or permissible), activities are halal, or permissible), Zakat (a religious tithe) is paid, and Zakat (a religious tithe) is paid, and wastefulness is avoided. wastefulness is avoided.

Emergence of Contemporary Emergence of Contemporary Islamic FinanceIslamic Finance

- Partnerships and Profit-sharing ventures consistent with the beliefs of Islam were commonly used to finance activities.

- Over time, the center of economic gravity moved to the western world, the profit sharing approach to structuring financial transactions fell out of favor and western financial institutions came to dominate the capital markets.

- Islamic financial institutions gradually succumbed to the ways of the west and adopted interest-based financial transactions. Muslim Community accepted the western or conventional financing methods

Emergence of Contemporary Emergence of Contemporary Islamic FinanceIslamic Finance

- The establishment of the Mit Ghamr The establishment of the Mit Ghamr Islamic Bank in Egypt in 1963 is viewed Islamic Bank in Egypt in 1963 is viewed as the starting point of the modern as the starting point of the modern Islamic banking movement. Islamic banking movement.

- Not all Muslims embrace Islamic finance Not all Muslims embrace Islamic finance with open arms, efforts within the with open arms, efforts within the Islamic finance movements are being Islamic finance movements are being made to use deceptive practices to made to use deceptive practices to circumvent shari’a circumvent shari’a

Basic Tents of Islamic Basic Tents of Islamic FinanceFinance

• Islamic finance encourages active participation Islamic finance encourages active participation of financial institutions and investors in of financial institutions and investors in achieving the goals and objectives of an Islamic achieving the goals and objectives of an Islamic economy.economy.

• It merges the ethical teachings of Islam with It merges the ethical teachings of Islam with finance as a means to meet the needs of finance as a means to meet the needs of society and to encourage socioeconomic justice. society and to encourage socioeconomic justice.

• Islamic finance prohibits trading in, for example, Islamic finance prohibits trading in, for example, alcoholic beverages, gambling, and porkalcoholic beverages, gambling, and pork

• The primary players in the Islamic financial The primary players in the Islamic financial systems are Islamic banks and the Islamic systems are Islamic banks and the Islamic “windows” of conventional, or western, banks“windows” of conventional, or western, banks

Islamic Bank DefinitionIslamic Bank Definition• ““A financial institution whose statutes, rules, A financial institution whose statutes, rules,

and procedures expressly state its commitment and procedures expressly state its commitment to the principle of Shari’a and to the banning of to the principle of Shari’a and to the banning of the receipt and payment of interest on any of the receipt and payment of interest on any of its operations”its operations”

• Or “whose aims and operations do not involve Or “whose aims and operations do not involve any element which is not approved by the any element which is not approved by the religion of Islam”religion of Islam”

• Or “exercise the activities pertaining to banking Or “exercise the activities pertaining to banking business and any activities considered by the business and any activities considered by the law of commerce or by customary practice as law of commerce or by customary practice as banking activities in compliance with the banking activities in compliance with the Islamic shari’a principles”Islamic shari’a principles”

Objectives of Shari’a in Islamic Objectives of Shari’a in Islamic FinanceFinance

• The principle objective of Shari’a is The principle objective of Shari’a is economic justice through equitable economic justice through equitable distribution of resources.distribution of resources.

• The objective of Islamic financial institutions The objective of Islamic financial institutions is the pursuit of profits without violating is the pursuit of profits without violating shari’a shari’a

• Among the most important policies or goals Among the most important policies or goals pursued by the Islamic financial system are pursued by the Islamic financial system are the following:the following:

1.1. shari’a-compliant financial products and shari’a-compliant financial products and services (must not based on the payment or services (must not based on the payment or receipt of interest)receipt of interest)

Objectives of Shari’a in Islamic Objectives of Shari’a in Islamic FinanceFinance

2. Stability in money value: Islam recognizes money as a 2. Stability in money value: Islam recognizes money as a store of wealth and as a means of exchange but does store of wealth and as a means of exchange but does not view money as a commodity that should be not view money as a commodity that should be bought and sold at a profit. So, currency should be bought and sold at a profit. So, currency should be backed by an underlying asset.backed by an underlying asset.

3. Economic development: financing infrastructure 3. Economic development: financing infrastructure projects is designed so that investment returns to projects is designed so that investment returns to both provider and the user of funds will reflect the both provider and the user of funds will reflect the success of the project. The mechanism of sharing success of the project. The mechanism of sharing profits leads to a close working relationships between profits leads to a close working relationships between the bank and the entrepreneur and is believed to the bank and the entrepreneur and is believed to encourage economic development as a resultencourage economic development as a result

Objectives of Shari’a in Islamic Objectives of Shari’a in Islamic FinanceFinance

4. Social development: social welfare 4. Social development: social welfare and development of the poor are and development of the poor are improved through the collection of improved through the collection of ZakatZakat

5. Resource optimization: funding is 5. Resource optimization: funding is provided only for projects that have provided only for projects that have the most favorable return-for-risk the most favorable return-for-risk forecasts, in addition to meeting the forecasts, in addition to meeting the criterion of being socially beneficialcriterion of being socially beneficial

Objectives of Shari’a in Islamic Objectives of Shari’a in Islamic FinanceFinance

6. Equitable distribution of resources: 6. Equitable distribution of resources: the distribution of income and the distribution of income and resources is intended to be resources is intended to be proportionate to the value offered proportionate to the value offered by participating parties.by participating parties.

Principles of Islamic FinancePrinciples of Islamic Finance

• Freedom from RibaFreedom from Riba

• Risk and Return SharingRisk and Return Sharing

• Shari’a approved activitiesShari’a approved activities

• Sanctity of contractSanctity of contract

• Avoidance of GhararAvoidance of Gharar

Forces Strengthening Islamic Forces Strengthening Islamic FinanceFinance

• Economic growth and liquidity Economic growth and liquidity • Investor appetite for shari’a compliant Investor appetite for shari’a compliant

instrumentsinstruments• Privatization and foreign direct Privatization and foreign direct

investment (FDI)investment (FDI)• Regulatory changes Regulatory changes • DiversificationDiversification• GlobalizationGlobalization• Information Technology (IT)Information Technology (IT)