chapter 6: islamic financial system

BPMS1013 Theory & Practice of Islamic Business 1

CHAPTER 6:

ISLAMIC FINANCIAL SYSTEM


Introduction• What is Islamic Financial System?


Introduction

A financial system that is based on Islamic principles and values, which eliminates riba and ensure a profit sharing mechanism in the financial system.

It may be characterized by the absence of interest based financial institution and transactions, doubtful transactions or gharar, stocks of companies dealing in unlawful activities, unethical or immoral transactions such as market manipulation, insider trading short-selling etc.


The Principles Of Islamic Finance

•Wealth must be generated from legitimate trade and asset-based investment. (The use of money for the purposes of making money is expressly forbidden)

• Investment should also have a social and an ethical benefit to wider society beyond pure return.

•Risk should be shared.

•All harmful activities (haram) should be avoided.


Prohibited Elements In Islamic Finance

RibaDefinition

Literally, it means excess, expansion, increase, addition or growth.

Technically, it refers to the “premium” that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or an extension in its maturity.


Types of riba

a) Riba al-nasi’ah•Pertaining to loan contracts. The term nasi’ah means to postpone, defer or wait and refers to the time that is allowed for the borrower to repay the loan in return for the addition or the premium. •Example:-

- selling and buying properties

- personal loans


b) Riba al-fadl•Pertaining to trade contracts. It refers to the exchange of different quantities or qualities of the same commodity.•Example:-

- a kilo of wheat being exchanged for 1.5 kilos of wheat.


Differences between profit and riba

RIBA PROFIT

Definition Stipulated surplus of debt. Riba exist as long as the exchange/transaction gives rise to inequality of counter values (al-fadl) and determent in time of exchange (al-nasiah).

Profit is the return on trade, which is the result of difference between revenue and cost, encompassing the effort and risk undertaken by the entrepreneur.

Prohibition

Prohibited in Islam. Permitted in Islam.

Counter value

Unequal counter value. Equal counter value.

Wealth Creation

Deals only with money thus do not create real stock of wealth.

Deals with real assets thus creates real stock of wealth from:i. Additional values of the goods

sold.ii. Increase in utility through

exchange.

Arguments

i. Money as commodity – invalidii. Riba actually brings soma

benefits - invalid

Always justified in Islam.


Gharar

Definition Literally, it means deception, danger, risk, and uncertainty. Technically, it means exposing oneself to excessive risk and danger in a

business transaction as a result of uncertainty about the price, the quality and the quantity of the counter value, the date of delivery, the ability of either the buyer or the seller to fulfill their commitment, or ambiguity in the terms of the deal.

Ibn al-Qayyim described gharar as a sale in which the vendor is not in a position to hand over the subject matter to the buyer, whether the subject matter is in existence or not.

Imam al-Sarakhsi defined gharar as any bargain in which the result of it is hidden.

Sheikh Wahbah al-Zuhaily defined gharar as a contract which contains a risk to any one of the parties which could lead to his loss of properties.


Types of gharar

a) Gharar yasir (minor/slight) – tolerated and will not invalidate a contract.

b) Gharar fahish (excessive/major) – not tolerated and may result in voidability of a contract.

Examples:-

- the sale of fish in the sea

- the sale of bird in the air

- the sale of unborn animals

- lost items


Maysir (Gambling)Definition

Also known as qimar.Refers to easily available wealth or acquisition of wealth by chance, whether or not it deprives the other’s right.

Qimar means the games of chance – one gains at the cost of other.

Example:- lotteries, illegal racing,


Partnership

Mudarabah (Profit sharing)

A profit sharing contract, with one party providing 100 per cent of the capital and the other party (the mudarib) providing its expertise to invest the capital, manage the investment project and, if appropriate, provide labour. Profits generated distributed according to a predetermined ratio, but cannot be guaranteed. Losses accrued are borne by the provider of capital, who has no control over the management of the project. Often used for investment funds, with investors providing money to the Islamic bank, which it invests as mudarib, taking a management fee.

Islamic Banking Activities And Money Market


A partnership between two parties who both provide capital towards the financing of new or established projects.

Both parties share the profits on a pre-agreed ratio, with losses being shared on the basis of equity participation.

MUSHARAKA


A method of asset acquisition finance. A contract between the bank and its client for the sale of goods at a price that includes an agreed profit margin, either a percentage of the purchase price or a lump sum. The bank will purchase the goods as requested by its client and will sell them to the client with a markup.The profit mark-up is fixed before the deal closes and cannot be increased, even if the client does not take the goods within the time stipulated in the contract.

MURABAHA

Cost-plus financing / buy-sell arrangement


Al wadi’ah (Safe-keeping)The bank may request permission to use customer funds deposited in these accounts as long as these funds will remain within the bank’s discretion. The bank does not share with the customer profits earned from the use of the customer’s funds but does guarantee the customer’s deposits. The bank may, however, reward customers with a hibah (gift) as a token of its appreciation for being allowed to use the funds. Hibah could be a portion of the profit generated from the use of the funds. Hibah may be paid at any time, but in practice, most Islamic banks pay hibah at a regular periodic interval, such as quarterly or semiannually.

Based On Saving


A contract where the bank buys and leases out equipment required by the client for a rental fee.

Ownership of the equipment remains with the lessor bank, which will seek to recover the capital cost of the equipment plus a profit margin out of the rentals payable

lease (sewa pajak)Ijarah (leasing)

PERSONAL FINANCING &

ASSET


Purchase assetUse a shari’ah system refers to the islamic law based on divine guidance ,as given by the Qur’an and the sunnah ,and embodies all aspect of the islamic faith ,including belief and practice.Based on mudarabah and musyarakah

AR -RAHNU

Ar-Rahn, or mortgage or collateral, is defined in the Islamic jurisprudence as “possessions offered as security for a debt so that the debt will be taken from it in case the debtor failed to pay back the due money.”

Ar-Rahn is a permissible contract in Shari’ah. It is known from the Sunnah that when the Prophet of Allah, Muhammad (SAW),.


Islamic Letter Of Credit• It is a written undertaking given by the Islamic bank to the seller (the

beneficiary) at the request and on the instructions of the buyer (the applicant) to pay at sight, or at a determinable future date, a stated sum of money within a prescribed time limit and against stipulated documents which must comply with terms and conditions.


Islamic Bank Guarantee•A guarantee Is promised by a third party to carry out the obligations owed by one person to another in the event of default.•Under the syariah, and in accordance with the principles of kafalah, an islamic bank may issue, at the request of the customer, an islamic bank guarantee (IBG) to a beneficiary named by the customer.•The kafalah principle used in (IBG) is a surely given by the first party who agree to discharge the liability of a third party in case the second party defaults in fulfilling his obligation


Qard Hassan Loan•interest-free loans or loans given to the purpose of welfare assistance•Debt repayments by certain parties to the other without profit or payment of any refunds made over time.•social responsibility or welfare assistance from the wealthy to those in need.


CONT…•No one should owe the creditors want to return the favor by giving a little consolation•“Sesiapa yang berbuat baik kepada kamu maka hendaklah kamu memberinya balasan yang baik.” (Riwayat Ahmad)


The Equity of Islamic Financial System Equity is an ordinary share issued by a company Equity market is a wide market that involves many sellers and buyers around the world

equity shares of companies are traded in equity market that are further classified as primary and secondary market


The Instruments Of Equity1. normal share

Shareholders have the right ownership, profit sharing rights, rights voting member of the Board of Directors

2. Major stock Structured so as to meet Islamic requirements such as payment of dividends

Irregular

3. Subscription right (TSRs & warrants) Owner warrants or TSR has the right to buy a certain number of shares at a

price set over a specified period

4. Call Warrants Refer to instruments which entitle the owner to purchase the number of

shares particular at a set price during the prescribed period.

5. Trust Based on Islam Refers to investment trusts in a managed fund by professional fund managers


1. partnership All operations are carried out in the form of Islamic banking and finance must be

parallel or follow the rules set by the Shariah. General principles of Islam can be summarized as follows

every transaction carried out must be with the full consent of the contracting parties.

The contracting membership must be perfect and the contract is not impaired by the things that can cancel it as coercion (duress) misstatement (misrepresentation) and err (mistakes)

Goods become the object of a contract must be known to the type, nature, and capable of delivered volume. It is also beneficial and clean in the eyes of Shariah.

Muamalah is not created on the basis of riba al-qimar (gambling), al-maysir, al-gharar (element not sure) and things that are prohibited.

Muamalah shall be protected from the elements of oppression (ihtikar) embargoed goods (talaqqi al-rukban) or excess profit that cause huge losses to the other contracting party (ghabn al-fahish)


Cont…2. Based on waged

In Islam, the source of financing is not practice the riba’

ensure fair wages policy for labor The forms of Islamic financing sources such as

Mudarabah, Musharakah, Bai Bissaman Ajil, Ijarah and others


SukukDEFINITION Sukuk : is the Arabic name for a financial certificate or an Islamic bond.

Sukuk are certificates of investment in a project in which the sukuk holders have an interest (or ownership) of the underlying asset or project sukuk issue.

Sukuk differ because sukuk shares do not have ownership over the assets of the company but have an interest / ownership of certain assets or projects.

Publisher sukuk issue sukuk as to raise funds to meet the capital requirements of the project or where the holder may sell sukuk in the secondary market or held to maturity sukuk.

Sukuk are generally in the form of equity, although can be secured through purchase of undertakings (purchase undertaking) in some sukuk structures.


Obective Sukuk

- To enable organizations: (1)to raise capital (2) expanding the investor base and (3) offering investment opportunities to new groups.


Types Of Sukuk

1.) Musharaka Sukuk

- Are used to finance businesses on the basis of partnership contracts.- Musharaka Sukuk are used for mobilizing the funds for establishing a new project or

developing an existing one or financing a business activity on the basis of partnership contracts.

2.) Ijara Sukuk

- These are sukuk that represent ownership of equal shares in a rented real estate or the usufruct of the real estate. These sukuk give their owners the right to own the real estate, and receive the rent.

3.) Mudaraba Sukuk

- Are often used for profit sharing between investors and entrepreneurs in ventures.- are used for enhancing public participation in big investment projects.

4.) Istisna Sukuk- The aim of Istisna Sukuk is mobilising the funds required for producing products that are

owned by the certificate holders.- Istisna Sukuk are quite useful for financing large infrastructure projects.


Fiqh Rules In Investment

• "(For) Profit (yield investments) must be to run the risk (meaning no fixed profit promise and investors must ensure keelokan goods sold if a sale contract)" [Hadith narrated by ImamAsh-Shafi `i, Imam Ahmad, Imam Ibn Hibban, Imam Abu Dawood: No. 3508; According to Shaykh Albanian: This Hadith Hasan]


Conclusion Basically, stand based on Islamic banking institution

is a must. However, each activity to be implemented should be reviewed carefully so as not to conflict with Islamic law. Recovery in the economy as a whole must be borne by the government so that justice can be applied in the lives of Muslims as a whole.


Q & A