ISLAMIC FINANCE TODAY
The pulse of ethical business July 2020
Fintech, An Enabler For Islamic Social Finance Zainab Ahsan Islamic bank as a Deposit -Taking Bank Saiful Azhar Rosly Why Takaful and Not Insurance? Rusni Hassan & Syed Ahmed Salman Smarter Sukuk Iman Ali Liaqat Role of Halal Investments in Controlling Inflation Lafeer Mufeeth Why Islamic Finance Ethica Institute ISSN 1800-1319
MIT Media and Publications
INSIDE
FINTECH Zainab Fida Ahsan ISLAMIC BANK Saiful Azhar Rosly IFT 4 An Enabler For Islamic Social Finance IFT 10 As Deposit taking bank
WHY TAKAFUL Rusni Hassan SMARTER SUKUK Iman Ali Liaqat IFT 14 And not Insurance Syed Ahmed Salman IFT 21 Islamic Investment Certificates
HALAL INVESTMENTS Lafeer Mufeeth ISLAMIC FINANCE Ethica Institute IFT 25 In Controlling Inflation IFT 28 A Basic Introduction
EDITORIAL Better Times are Coming, God Willing
All times are good times said a wise man If there’s one thing the pandemic proved- it once. Life is a cycle of birth and death, decay was that unbridled capitalism had utterly and renewal. Even what we think to be the failed humanity. It is in such trying times worst of times may well be the harbinger of that we realise more than ever the value of and lay the groundwork for the best of times. the Islamic scheme of things from its welfare The one thing that keeps us going is hope. system based on alms tax and charity to its Hope springs eternal in the human breast and time-tested financial system based on the where there is hope there is life. principles of mutual help and profit and loss sharing. It is with this message of hope that we present to you our readers a revived and renewed This is a system that is neither fickle nor Islamic Finance Today Digital Magazine, faithless and certainly not one that will coming at a time of global economic downturn abandon Rome to the wolves. Why, because in the midst of the COVID pandemic. You this system is a divinely given one with its may wonder at the timing of the release of roots firmly on the ground. It gives no room this third phase of IFT following on the heels for speculation and profiteering at the expense of the print version begun in 2006 and the of others by way of usury and other unethical online version started in 2015, but this is the means. And it is here to stay because there message we want to give- We are here to stay will always be a need for it, come what may. through thick and thin, because this is what Islamic Finance is all about! One bug has already hit the world and hit it hard, and there’s no need to pass the If there’s one thing that the crisis revealed bigger bug which is the bug of hopelessness as it unfolded, it is the utter failure of the and despair. Economic downturns and capitalist system based on human greed. depressions after all have a lot to do with Did not we see how the West responded to human mentalities just as much as it has to the pandemic. Italy was abandoned to the do with the conventional banking system. So wolves, so to say, by the rest of Europe and here’s to hope and to Islamic Finance to show the bulwark of capitalist commercialism, the the way out of these seemingly dark times. US could simply not handle the crisis because its entire system was only based on money Yes there’s light at the end of the tunnel. let’s making from its healthcare to other agencies. move towards it! Asiff Hussein Editor-in-Chief - Islamic Finance Today
Editor in Chief - Asiff Hussein Layout & Design - Mohamed Aabith Proprietor & Producer - Muhammad Ikram Thowfeek Publisher - MIT Media and Publications
No part of this publication may be reproduced in any form without the prior written permission of the publisher. Views expressed in this publication are not necessarily those of the publisher. FINTECH An Enabler For Islamic Social Finance By Zainab Fida Ahsan
Islamic Finance Today - July 2020 IFT 4 he onset of change in our lives today, from technology to Tglobalization to climate change has led to a world of accelerating change from which new abundance and prosperity bloom, but where opportunity remains unjustly distributed. While the pace of development and progress towards Industry 4.0 is pretty impressive, there still remain vast differences in socio-economic empowerment and prosperity across demographies.
Why FinTech Matters
FinTech is the term given to financial service firms whose products or services are based upon technology, often resulting in highly innovative, pioneering services. Fintech firms are often characterized as high-growth, combining innovative business models and technology to disrupt the financial sector.
FinTech has the potential of opening the floodgates of progress and financial inclusion, as it can help navigate both costs of operations as well as the tedious processes involved in creating regulatory changes in the workings of central authorities.
While regulatory controls are of course necessary for any system to work efficiently, technology and digitalisation have enabled quicker processing and handling of economic interactions. This has led to the development of RegTech (Regulatory Technology) and initiatives by some progressive Central banks to establish sandboxes to support the startup ecosystem in their economies.
Blockchain technology is a key mechanism deployed in FinTech projects and has created quite a hype in the financial world. The World Economic Forum predicts that 10 percent of the world’s GDP could be stored using blockchain by 2025. If just a fraction of the market could be replaced with peer-to-peer transactions and cryptocurrencies there could be huge potential benefits, especially the creation of opportunities in the developing world.
One of the biggest issues that unbanked people face is financial literacy. Sometimes those who could be included don’t have the literacy skills to navigate the complex documentation required, or understand how the system as a whole will work. In fact, many of those that could acquire formal identification and finance simply don’t know how.
4 Islamic Finance Today - July 2020 IFT 5 Future of Blockchain
Humaniq, a tech startup powered by blockchain technology, hopes to solve this problem by providing an easy-to-use interface that can be understood by anyone, regardless of language or educational background. The developers are using the smartphone revolution to help the developing world move a step closer to full-scale financial inclusion. Through facial recognition software, the application offers an alternative form of identification, allowing users to work, borrow, lend, save and pay across the internet. Humaniq creates win-win opportunities for both partners and the world’s poorest, using a system built upon humanitarian capitalism – profit with a purpose – that could empower lives and offer a high ROI for investors.
International agencies such as the The United Nations World Food Programme (WFP) are deploying cutting-edge blockchain technology to make cash-based transfers faster, cheaper and more secure. In Jordan’s Azraq camp, for example, 10,000 refugees are now able to pay for their food by means of entitlements recorded on a blockchain-based computing platform. This was developed by WFP as part of a pilot known as ‘Building Blocks’.
WFP’s system relies on biometric registration data from the United Nations High Commissioner for Refugees (UNHCR) and uses biometric technology for authentication purposes. Refugees purchase food from local supermarkets in the camp by using a scan of their eye instead of cash, vouchers or e-cards.
Islamic Finance Today - July 2020 IFT 6 Towards Financial Inclusion
Many insights from the industry show recognition for the role of technology in revolutionizing many sectors of the global economy, and how finTech can further the cause of financial inclusion. There are interesting parallels with the development objectives envisioned in the Islamic tradition.
Financial technology essentially disrupts traditional methods of delivering financial services, with philanthropic spending not being an exception. While crowdfunding solutions and blockchain are already being applied in certain jurisdictions to address social finance issues, there still remains a void of effective policies in the Islamic social welfare sector. Social finance is vitally important due to its scale, inclusiveness, and differentiation.
According to Aamir A Rehman, Senior Advisor on Islamic Finance, UNDP, Social finance has long been a means for Islamic finance to contribute to the world. Embracing new technologies, enhanced governance practices, and international partnerships can help the sector expand its contributions and communicate these contributions as part of a common global cause.
6 Islamic Finance Today - July 2020 IFT 7 For instance, the Islamic Development Bank Group (IsDB) estimates the potential of Zakat alone to be as much as US$1 trillion per year. However, there is significant frustration with the lack of transparency, accountability and impact of traditional forms of giving. Crowdfunding initiatives that connect donors with entrepreneurs may be a promising solution to this frustration.
One such initiative is Human Crescent, a new strategic platform that lends voice and support to displaced populations worldwide. By combining the power of storytelling by sharing the personal journeys of refugees, activists and influencers in the space with blockchain-driven crowdfunding, Human Crescent seeks to contextualise traditional beneficiary groups to humanitarian needs of the modern world.
LaunchGood is a global crowdfunding platform to support Muslims all across the world by helping them raise funds for their campaigns. It is a powerful example of how the power of community and crowdgiving can create exponential impact in millions of lives. EthisCrowd, part of Ethis Ventures, is a successful Real Estate Islamic Crowdfunding Platform that enables people to invest in affordable social-housing projects. Currently, it offers its community of 25,000 ethical and Islamic crowd- investors and donors from 65 countries to provide funding for Social Housing development projects in emerging Indonesia.
Impact of Innovation
Other innovations include Sharia-compliant robo-adviser platforms that provide financial services to retail investors. One such platform, New York’s Wahed Invest, in September launched two Sharia compliant index-tracking funds. U.S. firm Blossom Finance, meanwhile, will launch what it claims will be the first digital sukuk in late 2018. Using the Ethereum blockchain, retail investors will be able to invest in sukuk, which will then use the proceeds to fund Sharia-compliant microfinance initiatives in Indonesia.
While we must acknowledge that crowdfunding is not a panacea and there are risks, appropriate regulation and investor protections can be built, through ingenuity and technology. Crowdfunding holds the promise of bringing together resource-rich and resource poor demographics to ensure both top-down support and Bottom-of-Pyramid impact in a sustainable and scalable fashion, towards realizing the most efficient use of social capital, human collectivism and a vibrant, participative and inclusive economy.
Islamic Finance Today - July 2020 IFT 8 A major source of capital for the development of communities, are the instruments of Zakah and Awqaf. The efficient utilisation of these resources could entail amongst others, the benefits of financial independence and self-sufficiency of the community, while considerably taking away the burden from the government in this regard.
This presents both a challenge and an opportunity for non-government institutions to disrupt the ecosystem and implement specialized, effective solutions to pressing economic problems. There is a need for policymakers in the administrations of developing economies to explore opportunities of collaborative, SDG-driven initiatives including public- private partnerships to achieve social development goals at scale.
Financial Technology, if utilised effectively, can greatly accelerate financial inclusion, create more opportunities across the developing world and establish an enabling environment for the scalability of Islamic Social Finance.
8 Islamic Finance Today - July 2020 IFT 9 ISLAMIC BANK AS A DEPOSIT-TAKING BANK A FALSE START? Prof. Saiful Azhar Rosly INCEIF
Islamic Finance Today - July 2020 IFT 10 bank bearing an Islamic label has a lot more to perform than their A conventional counterparts. Profitability is paramount. Efficiency, liquidity and capital adequacy are equally important. Islamic banks have to further fulfil expectations of the Islamic values they carry in their business operation. These include compliance to Shariah rules and ethics. The maqasid Shariah or the purpose of the Law is an additional Islamic input that has put high expectations of Islamic banking.
For example, Islam prohibits riba (al-baqarah 275) which is a fundamental rule. In the maqasid, the intent of prohibiting riba is the promotion of justice through the protection of property (al-mal) one of which is savings. In the riba system, the bank takes savings of the ordinary people as deposits and pays them 3%. The bank uses the deposits to make loans at 7% to the big corporations who earns 40% profit from their projects. In this way, the rich become richer, the poor become poorer. Savers who make deposit placement may see their interest income even less after accounting inflation. As the banking system uses cheap deposits to fund big business, it intensifies income disparity and social discontent. For instance, small business and start-ups are not viable to banks as they do not have the collaterals to support loans.
Islamic banking too is challenged by similar issues. They are established as deposit-taking banks and commercial banks as well. The challenge is to conduct business under these two banking models where al-bay constitutes the basis of banking products. The Quran says, “Allah has permitted al-bay but prohibits riba”. As the Quran prohibits riba, it also promotes al-bay as the alternative to riba. Al-bay which is trading and commerce describe wholesale and retail business but the main lesson is the taking of risk in business. In al-bay, the merchant uses his capital fund to purchase goods from supplier which he intends to sell at a profit to consumers. In good times he makes profit but he also make some loss when no one buys his goods. Hence, he faces business risk as he putting his capital at risk to adverse market movement.
Al-Bay in Real-Sector Financing
On the contrary, the merchant can also use his capital funds to make loans with riba. The loan which is usually collateralized is therefore risk-free, as the merchant can recover the loan from the sale of the collateral. In the Jahili period, defaulters became slaves instead when their loans do not carry any collaterals. The payment of riba and loan are therefore fully guaranteed. These two opposites of al-bay and riba must be properly distinguished to highlight a fundamental rule emerging from the Quranic verse (2:275) that one must take risks to justify the taking of profits, hence the legal maxim “al-ghurmu bil ghuni” – profit is accompanied with loss. Riba is where risk is avoided in return for fixed interest and loan repayment.
10 Islamic Finance Today - July 2020 IFT 11 Traditional contracts available to Islamic banks are grouped under sale- based, lease-based and equity-based. These contracts are not made for a deposit-taking bank model that most Islamic banks adopted today. Risks in sale, leasing and equities transactions are different from risks that conventional bank normally accepts. Risk appetite is set by bank directors who are responsible for policies and strategies to achieve bank corporate objectives.
The risk-appetite of deposit-taking bank is constrained by the size of capital it is holding which is defined by the Leverage Ratio. Basel 3 requires leverage ratio of 3, which means that for 1 dollar of asset, the bank must hold 3 cents as a support. So banking is a highly leverage business, hence control is needed to prevent banks from taking excessive risks as they are using peoples’ money to make loans. For these reasons, Basel and central bank authorities put high risk-weights on sale, lease and equity-based products up to 400% as they carry high default risks. It has frustrated the use of these real-sector contracts in favour of loan- like tawaruq products.
Deposit-Taking Islamic Banking
Much of the problem is associated with bank deposits which can be withdrawn on call. Deposits are guaranteed funds, hence depositors hold no risks to earn interest and hibah. For this reason, bank is further required to observe Basel 3 capital adequacy requirement which is set at 10.5%. Islamic banks will be stressed-up with high capital holding if they plan finance the real-sector activities solely because deposit funds are considered borrowed funds even if they are labelled as say, mudarabah investment deposits.
In this way, the future of using real-sector contracts is doomed when Islamic banks continue to operate on the deposit-taking system. Real- sector contracts promotes entrepreneurship, employment and income creation and all these will be frustrated when Islamic banks remained to be deposit-taking banks.
Islamic Banks without a Development Objective
Islamic banks are also established as commercial banks who only give finances to borrowers who have collaterals and guarantees. These will exclude small and medium scale business who are in need of funding to start-off their projects. But these companies also need nurturing and assistance to grow which commercial banks are not made to do. The development role of commercial banks is truly absent as they do not have a mandate to pursue that social objective. The only mandate is fulfilling the profit objectives hence return on equites (ROE) is key to banks. The development of banking is left to governments as they established many development banks run by government agencies.
Islamic Finance Today - July 2020 IFT 12 The way forward is the promotion of investment account (IA) fund. These non-deposit funds allows the investors to carry the risks of the fund users who are the small and medium scale business (SMEs). The bank who act as an agent (wakil) will identify SMEs and structure IA based on the profiles of the SMEs. Hence the risk-appetite of IA can be connected to the risk-profile of the SMEs. This system will evidence the use of true Islamic contracts such as salam, istisna, mudaraba and musharaka, hence taking away Islamic banks from converging into mainstream banking as currently taking place.
Way Forward
The way forward is the promotion of investment account (IA) fund. These non-deposit funds allows the investors to carry the risks of the fund users who are the small and medium scale business (SMEs). The bank who act as an agent (wakil) will identify SMEs and structure IA based on the profiles of the SMEs. Hence the risk-appetite of IA can be connected to the risk-profile of the SMEs. This system will evidence the use of true Islamic contracts such as salam, istisna, mudaraba and musharaka, hence taking away Islamic banks from converging into mainstream banking as currently taking place. In the longer-run, as the size of IA increases, deposit funds will only be utilize for cash management.
With digital banking coming on board, demand deposits may not be used to make loans anymore. Islamic banks will no longer be leveraging on borrowed funds to extend finances. Hence capital holding is minimal to offset any loss arising from operational risk as the bank now is largely driven by fee-based income. The funding role will be taken over by investment account that serves to fund household and business using true Islamic financial instruments.
For example, in home financing, the IA fund will buy the house from the developers and sells it to the customer on credit or leasing. This is not happening under a deposit-taking commercial Islamic bank today. In SME financing, IA holders will act as the rabbulmal while the former as mudarib. Banks as agents will earn fees from SME listing and IA issuances. In this way, blue-ocean and green fields in Islamic banking are plenty to benefit from.
But these are not up for grabs as Islamic banks today are still doing business with the money-lender mentality. Most Islamic banks financing today are driven by deposit funds and unlikely to move forward unless the deposit regime is rationalized along the conception of al-bay as risk- taking system.
12 Islamic Finance Today - July 2020 IFT 13 WHY TAKAFUL AND NOT INSURANCE? Rusni Hassan & Syed Ahmed Salman Rusni Hassan is Professor at the Institute of Islamic Banking and Finance (IIiBF), International Islamic University Malaysia. Syed Ahmed Salman is a Senior Lecturer at the Faculty of Business and Accountancy, Lincoln University College.
Islamic Finance Today - July 2020 IFT 14 Need for Insurance Allah alone is all-knowing. Human beings possess limited knowledge and cannot forecast or predict the future with 100% certainty. In addition, we have limited capacity to avoid unfortunate events. By nature, we are born with limited ability and capacity to control any future incident, which means we are perpetually exposed to risks. Within the context of insurance, risk is a danger or unfavourable exposure to misfortune. Health deterioration, accidents, natural disaster, and economic loss are examples of risk.
Although we have limited capacity and knowledge, Allah has given us intellect (Aqal). With it we are able to decide the best course of action to mitigate the impacts of misfortune. One of the means to minimise financial loss in the event of misfortune is by subscribing to insurance. It can provide financial assistance to insurance policy holders by allowing them to make claims according to the terms and conditions of the insurance policy.
Insurance Practices in Islam Insurance is the risk mitigating instrument that helps ease the financial burden of misfortune afflicting the policy holders. Islam encourages helping and promotes a sharing and caring society. It does not reject the idea of insurance. However, its practices involve elements prohibited in Islam. These prohibited activities are interest, uncertainty, gambling, and investment in non-Shari’ah compliant business activities, which are prohibited due to their unethicality and injustice.
Prohibition of Interest in Islam
Interest is prohibited in Islam because it is unjust to the socio-economy due to unfair distribution of wealth. Interest is earned by the lender without bearing any risk by deriving a predetermined amount of interest regardless of the financial situation of the borrower. Only the person with surplus money or a relatively well-to-do person can lend money and thereby receive interest. This causes wealth to circulate solely among the rich. It increases the gap between the rich and the poor and breeds hatred and jealousy in the community. The prohibition of interest is clearly stated in the following sources of Shari’ah:
“O those who believe, fear Allah and give up what still remains of the riba (interest) if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be wronged. And if there be one in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. And they shall not be wronged”. (Surah Al-Baqarah, 275-281)
14 Islamic Finance Today - July 2020 IFT 15 Islam encourages providing interest free loans (Qardul Hasan loan) to help people in need, as it fosters brotherhood and solidarity in society. Moreover, partnership types of business relationship such as Mudarabah and Musharakah are encouraged. Under Mudarabah, the capital provider provides the capital and the entrepreneur runs the business on behalf of the capital provider.
When there is profit, they share it according to the predetermined ratio, while in the event of loss, the capital provider bears the loss unless it is not due to the negligence of the entrepreneur. Under Musharakah, two or more partners contribute the capital in the business with the view of making profit. The profit is shared according to the agreed ratio and the loss is borne according to the capital contribution ratio.
In Mudarabah, the capital provider provides the capital to the entrepreneur, rather than lending the entrepreneur on interest. By doing that, the capital provider helps the financial need of the entrepreneur while earning profit from the business run by the entrepreneur. At the same time, the entrepreneur can enjoy the profit from utilising the capital provided by the capital provider. This type of business arrangement creates a win-win situation for all involved parties.
In the case of loss, the capital provider bears the loss, not the entrepreneur. This is because the entrepreneur needs money for the business and does not want to incur any loss, or else, he will be in debt in addition to losing his time and effort from running the business. Similarly, in Musharakah partnership, the losses are borne according to the capital contribution ratio, i.e. the more capital you invest, the more loss you are supposed to bear. The partner with lower capital investment is not asked to bear the same amount of loss as the higher capital investment partner.
Islamic Finance Today - July 2020 IFT 16 This shows that there is some consideration for the lower investment capital provider. While interest contributes to an unfair and unjust society, the practices of interest free loans and partnership businesses strengthen brotherhood in the community.
Prohibition of Uncertainty in Islam Uncertainty is not a fair business practice because it favours one party at the expense of the other and can result in dispute and unethical consequences. Prohibition of uncertainty is evidenced in the following:
O you who believe! Intoxicants (all kinds of alcoholic drinks), and gambling, and Al-Ansab, and Al-Azlam (arrows for seeking luck or decision) are an abomination of Shaitan’s (Satan) handiwork. So, avoid (strictly all) that (abomination) in order that you may be successful. Shaitan (Satan) wants only to excite enmity and hatred between you with intoxicants (alcoholic drinks) and gambling and hinder you from the remembrance of Allah and from As-Salat (the prayer). So, will you not then abstain? (Surah Al- Al-Ma’idah, 90-91).
For instance, it is not allowed to sell the fish in the water because there is no certainty about the type of fish, its weight etc. Nowadays, many international and local governing bodies are emphasising the issue of information asymmetry, i.e. the managers have more information about the company compared to the outside shareholders. Due to information asymmetry, investors are not well informed about the actual performance of the company and consequently causing uncertainty in their investment. It is unfair and unjust to the investors because they are the real owners of the companies. The requirement of full disclosure becomes mandatory for public listed companies to reduce information asymmetry, minimise uncertainty, and enhance transparency.
16 Islamic Finance Today - July 2020 IFT 17 In Islam, full information disclosure to enhance transparency has been highlighted in the following:
“And cover not Truth with falsehood, nor conceal the Truth when ye know (what itis)”. (42) (Al- Baqarah: 42).
In the case of insurance, the policy holders pay the premium to the insurance operators, however, the subject matter, i.e. for what policy holders are paying is uncertain. Although the policy holders have the intention to claim damages against the insurance operators, there is uncertainty on the occurrence of future misfortune or peril.
Prohibition of Gambling in Islam
Gambling is a consequence of uncertainty because gambling is winning by chance. The winner does not need to exert effort (iwad) in gambling and relies on the chance of luck. Insurance practice involves gambling because the insurance operator can make profit or not depending on the occurrence of the claims. When the insurance policy holder makes the claim, he wins while the insurance operator loses because it is the expense for the operator.
Similarly, when there is no claim, the insurance policy holder loses their premium, but that premium becomes the profit for the insurance operator. By looking at this practice, the gain of one party is at the loss of another and gain or loss depends on the occurrence of future event, i.e. chance. Thus, gambling is not allowed in Islam and it has been prohibited based on the following:
They ask you (Prophet) about intoxicants and gambling: say, “There is great sin in both, and some benefit for people: the sin is greater than the benefit.” They ask you what they should give: say, “Give what you can spare.” (Surah al- Baqarah, 219)
Prohibition of Investment in Non-Shari’ah Compliant Business Activities in Islam When the insurance operator receives the premium, it will be invested in income generating activities such as investment in short-term deposit or companies by buying the shares. The investment revenue must not be generated out of prohibited activities such as investing in the interest- bearing loan or liquor business.
Conventional insurance operators are not currently imposed any Shari’ah restriction on where they can invest. They can invest anywhere regardless of Shari’ah compliance.
Islamic Finance Today - July 2020 IFT 18 However, the practice of insurance involves interest, uncertainty, gambling and involvement in prohibited elements. Thus, Shari’ah scholars unanimously agreed on the prohibition of conventional insurance. In 1972, the Malaysian National Fatwa Council, and in 1985, the Islamic Fiqh academy under the patronage of the Organisation of Islamic Conference (OIC) in its resolution no. 9 (2\9) declared that insurance is prohibited from the Islamic perspective. Similarities and Differences between Insurance and Takaful
There is a similarity between insurance and Takaful, namely providing financial assistance to the policy holders in the event of misfortune according to the terms and agreement written in the policy. The main differences between them are related to sources of ruling, originated principle, contractual relationship, and motivation, choice of investment, risk and benefit. In insurance, it is ruled by the man-made law while in Takaful, it is derived from the sources of Shari’ah.
The originated principle in insurance can be traced to the Babylonians around 1,750 B.C. During that period, Mediterranean sailing merchants in Babylon made an extra amount of payment in addition to the principal borrowed in order to cover their financial loss in the case of sinking of the ship and loss of goods from robbery and bad weather.
In the case of Takaful, it started from the practice of Aqilah during the time of the Prophet (PBUH). During that time, the killer’s family or relatives make contributions to the deceased family with the intention of providing financial assistance. In other words, the original principle of Takaful is based on mutual help and donation. In insurance, the contractual relationship is bilateral because the insurance policy holders pay the premium for exchanging with the claims in the future.
In Takaful, the contractual relation is unilateral since it is based on donation, whereby that contributed money will be used to provide financial assistance to the Takaful participants according to the terms and conditions of the Takaful policy. In insurance, the primary intention of the operators is to make the profit.
The aim is still to make profit within the Shari’ah framework and hence the consideration about the need of the society is used as a moral filer in conducting the business. In insurance, there is no religious prohibition related to the investment while in the case of Takaful, the operators cannot make the investments prohibited by Shari’ah.
18 Islamic Finance Today - July 2020 IFT 19 Prohibited investments from Shari’ah are any investments not free from interest, uncertainty, gambling, and prohibited business activities such as alcohol, gambling and pork.
Similarities and Differences between Insurance and Takaful
Insurance is based on the concept of risk transfer in which policy holders transfer their risk to the insurance operators while in Takaful, the concept is based on risk sharing, whereby the Takaful participants share the risk of financial loss faced by other members. In insurance, the premium paid is revenue for the operator and belongs to the insurance operators. The only benefit that insurance policy holder can receive is the claims if there are any in the future.
In Takaful, in addition to the claims, the participants are allowed to share the profit or surplus, depending on the Takaful models adopted.
Current Status of Takaful Industry: Global Aspect
The total number of Takaful operators in the key market is 174 comprising 34 in Saudi Arabia, 11 in Malaysia, 43 in GCC countries (excluding Saudi Arabia), 29 in ASEAN (excluding Malaysia), 12 in South Asia, 36 in Africa, and nine in the Levant.
Family and medical Takaful are the major business lines in the markets. In addition, Takaful industry is widely spread to non-Muslim countries such as United Kingdom, Canada, United States, Thailand, and Singapore.
In summary, Takaful has been introduced as an alternative to insurance in order to avoid interest, uncertainty, and gambling. These elements are prohibited in Shari’ah based on their unethicality. Takaful is based on the concepts of solidarity, brotherhood, and mutual cooperation. It is an ethical product not meant for any particular religious group or community.
Participating in Takaful means you are helping yourself and other fellow human beings in the case of financial loss due to misfortune. Very importantly, participating in Takaful can promote a caring and sharing community.
Islamic Finance Today - July 2020 IFT 20 SMARTER SUKUK Iman Ali Liaqat
20 Islamic Finance Today - July 2020 IFT 21 slamic Finance is the largest sector of the Global Islamic Economy Iwith global assets over US$2.4 trillion as of 2017, and projected growth to US$3.8 trillion [1]. The Islamic Principles embedded in the Islamic Economy are the global principles of ethicality and sustainability, attracting both Muslims and Non-Muslims who look for more ethical ways of banking and financing projects.
The 4th Industrial Revolution driven technologies are exponentially disrupting the 20th century financial services market and the Islamic Finance Sector is no exception. Islamic Fintech has the potential to disrupt all aspects of the industry developed on the basis of Shariah principles[2].
One such technology rapidly emerging in the Fintech arena is “Blockchain”. This Distributed Ledger Technology can greatly help develop Shariah compliant products to support financial inclusion, increase competitive portfolio of products, target the untapped markets and most importantly, increase efficiencyand reduce costs. With Blockchain currently disrupting trade finance, it shows great potential in the business and consumer financing market as well, like the Sukuk market in Islamic Finance.A leading example of Blockchain enabled Sukuk to date is Blossom Finance in Indonesia.
Sukuk -Islamic Investment Certificate
In the classical commercial Islamic literature, Sukuk referred to certificates issued to government officers, in form of salary, which could be redeemed for their personal and household expenses. Now Sukuk have taken a different form and are considered a substitute to conventional bonds.
Securitization, also called “Taskik” in Islamic Finance, is a process of pooling tangible assets and packing them into securities, called Sukuk, which is then distributed to investors, giving them right to receive a share of the profit generated from the underlying asset traded on the secondary market, or involved in investment activities through Ijarah, Murabahah, Istisna’ or a combination of these contracts.Sukuk are an ideal source of finance for governments and companies looking for Shariah compliant products that foster sustainable economic growth.
Thus what makes Sukuk special and different from conventional bonds is that it is backed by tangible income generating assets, profits of which are distributed to investors, rather than calculating the interest on principle amount. Most importantly, in case of default, bond holders are left with bad debts, while Sukuk holders can claim the valuable asset.
Islamic Finance Today - July 2020 IFT 22 Global State of Sukuk
Investors and issuers prefer investing in Sukuk markets in Malaysia, UAE and Saudi Arabia, where investors are also attracted by markets in other GCC countries like Qatar, Bahrain and Kuwait. Sovereign Sukuk are currently planned in African countries like Niger, Kenya and Nigeria.
Other potential entrants include Kazakhstan, Oman, Ivory Coast, Togo and Jordan[3]. Sukuk offerings offer issuers an opportunity to tap into both the growing Islamic investor community and also the Western institutional investor community, as the Sukuk market is increasingly becoming attractive to European and US investors as they seek to diversify their portfolios and achieve higher returns.
Challenge of Sukuk Issuance
The main reason investors, both Shariah-compliant and non-Shariah- compliant, prefer investing in Sukuk is due to its inherent feature of diversification and as investors deem other assets, like equities and real estate, to be riskier, especially in a period of dropping oil prices. To date, most issuers are sovereign and financial institutions.
But with the demand for Sukuk increasing, other financial and non- financial corporate institutions are also looking for ways to successfully issue Sukuk and enjoy its full financial benefits. Corporate issuers being smaller in size face a major challenge of high relative cost associated with smaller issuances, especially since issuance costs are mostly fixed, so they are not able to capitalize on economies of scale to make the issuance process cost effective.
Higher required yields from investors together with high issuance costs are likely to discourage corporations from issuing Sukuk where other interest based options might prove a cheaper funding option which is a loophole the Sukuk market must address.
Smart Sukuk
Blockchain, the emerging Distributed Ledger Technology, has the potential to address these challenges. It would eliminate the need of intermediaries and simplify documentation and compliance checks through Smart Contract integration, reducing cost and time and make it possible for small and medium enterprises (SME) to issue their own Sukuk using the new technology.Blockchain will also build strong trust relations between issuers and investors as it enhances transparency and eliminates any fraud or speculations in Sukuk transactions.
22 Islamic Finance Today - July 2020 IFT 23 The first Smart Sukuk was introduced by Blossom Finance, an Indonesia based Fintech company, founded by Matthew J. Martin, that uses Ethereum Smart Contract based Blockchain smart contracts to enhance the efficiency. Blossom Finance has evolved from a Shariah microfinance investment intermediary to integrating advance technology to give new shape to Shariah compliant financial services, Smart Sukuk being one of the prominent examples.
Blossom’s Smart Sukuk functions by collecting funds from investors in exchange for Smart Sukuk Tokens that represent part of ownership in thelarger Sukuk. Once payment is received from the institution (borrower), the Smart Contracts automatically distribute funds to the Smart Sukuk Token holders in proportion to their investment, without the need of any intermediary. Another special feature of this Smart Sukuk is that is supports the issuance of Sukuk in local currency [4].
This is one leading example of how Blockchain made Sukuk smarter, and enables SMEs and small investors to be part of the global Sukuk market. With the increasing demand for Shariah based services like Islamic Investment Certificates together with the evolution of Islamic Fintech, the future of Sukuk issuance remains bright in the long term and shall soon be seen as a widely adopted instrument by the wider economy.
Notes: [1] DIEDC, Thomson Reuters, DinarStandard . (2018/19). State of the Global Islamic Economy. [2] DIEDC; DinarStandard. (2018). Islamic Fintech Report . [3] Thomson Reuter. (2017). Sukuk Preceptions & Forecast Study . [4] Blossom Finance: https://blossomfinance.com/
Islamic Finance Today - July 2020 IFT 24 ROLE OF HALAL INVESTMENTS IN CONTROLLING INFLATION By Dr.Lafeer Mufeeth
24 Islamic Finance Today - July 2020 IFT 25 nflation is a major concern of economists worldwide because it affects Ipeople everywhere on earth. Basically it refers to the measure or rate by which the general prices of the basic needs and wants of peoples rises and the purchasing power of money declines. As prices increase, monetary value decreases, thus prompting consumers to spend more money on goods and services.
Inflation is usually calculated by means of a consumer price index using the average prices of some basic goods and services to measure the rate of inflation. A basic law in economics is the law of supply and demand. In fact, almost every economic activity is the result of the interaction of the forces of supply and demand. If the supply of a good rises, the price falls. Conversely, if the quantity of a good demanded falls, the price rises. Simply put, if the supply increases, the price decreases, and if the supply decreases, the price increases.
Thus, there is an inverse relationship between price and quantity supplied. It is a fundamental economic principle that when supply exceeds demand for a good or service, prices fall. When demand exceeds supply, prices rise. Pitfalls of the Conventional Interest-based System
In essence, the conventional (interest-based) investment system expects money to create money without any input of labour, entrepreneurship or risk-taking on the part of the lender. The borrower has to exert labour, use his entrepreneurial skills and take all the risk, but the lender has to do nothing. Yet he or she expects to receive a fixed sum in return just because he or she has the money.
But at what cost? Let’s remember that much of the money in circulation consists not of liquid cash, but credit, which is the money banks have lent to individuals and companies. The banks as a matter of course will demand interest on the money lent. However, there’s a hitch. For this interest to be paid, the amount of money in circulation must increase. This extra money is not created based on real needs, but supplied by the banks as additional money by making more loans which are also made at an interest. The unhappy result is that the money supply is increased without any concomitant increase in commodity supply.
Causes of Inflation
So let’s get to the basics. Increasing money supply at a rate faster than the growth in real output causes inflation. Why is this so? This is because more money is now chasing the same number of goods which are limited. So what happens is that the increase in demand for goods causes firms to up their prices. The reason is simple. If they cannot cope with the demand, the next best option is to increase prices.
Islamic Finance Today - July 2020 IFT 26 If the money supply were to increase at the same rate as real output, then prices would be stable and remain the same.
It may be counter-argued that banks increasing money supply would lead to more production, but this is not how the real economy works. This is because investments are not necessarily in the areas where there are limited number of goods. It is in real estate and lucrative areas such as alcohol, tobacco, casinos and arms production. In other words, just because money supply increases, it does not mean it meets a nation’s basic needs and wants.
On the other hand, increasing the money supply continuously so that interest can be paid spurs inflation. This must be so because increase in wealth comes from increased income from products and services that companies offer when they cannot cope with demand. The difference is absorbed by inflation.
Why Islamic Investments?
The Islamic system of production involves capital being invested only by those who are also taking a risk on a profit sharing and loss bearing basis. Since lending on interest is not allowed, entrepreneurs use their own capital or mobilize capital for production by agreeing to share profits or bear losses according to the proportion of their investment. Further, investments can only be made in limited productive areas and not lucrative, high return areas such as liquor, casinos vulgar entertainment and the arms industry.
Thus what happens is that investors put their capital in activities that increase the supply of basic goods and services. Here one would find that there is always a close link between financial flow and productivity. Any profits an Islamic investor makes comes from investing money to produce the needs and wants of people.
As we know, there is limited investment in the fields of agriculture, clothing and shelter which are the basic needs of any human society which they cannot do without. Thus the limitations Islamic investors are subject to is a good thing because it discourages investments in unproductive, destructive activities and channels investments into productive uses fulfilling the basic needs of people.
Such investments that meet the most basic needs of the population tend to mitigate the pace of decline of the purchasing power of money which we call inflation, thus achieving equilibrium between demand and supply and controlling inflation
26 Islamic Finance Today - July 2020 IFT 27 BASICS WHY ISLAMIC FINANCE A simple introduction to Islamic finance for newcomers and veterans alike, looking at what really sets interest-free finance apart from conventional finance
By Ethica Institute of Islamic Finance (https://ethica.institute)
Islamic Finance Today - July 2020 IFT 28 BASICS
slamic finance appeals to common sense: buy and sell real assets and Iservices; sell only what you own; buy and sell only the ethical. These commercial truisms arouse no doubt to anyone except those intoxicated by the prospect of wealth at any cost.
Without the rapacious greed of capitalism to contend with, nor the unnatural self-denying vagaries of socialism to bear, Islam sets the balance at the middle course. Profit within reason, but with people and the environment in mind.
Islam, nor any thinking individual, does not simply accept as self evident that just because someone has more money than another he has the right to charge for lending that money, without doing any other work. This is the very essence of the rift that widens between rich and poor.
We look at three examples that clearly illustrate this middle course.
What do President Obasanjo of Nigeria, Nick the UK homebuyer, and Faisal the American college student all have in common? They are all trying to pay off loans that seem to increase every single day. What started off with a seemingly small interest rate ballooned into something completely unattainable. We will look at each of their examples a little later.
How Is Islamic Finance Different?
First, let us answer the big question on everyone’s mind: How is Islamic finance different from conventional finance? It looks the same. The result is often the same. What is the difference? The best way to find out is with a simple, real-world comparison. Let us take $10,000, for instance. And let us compare what a conventional bank can do with this $10,000 and what an Islamic bank can do.
First, the conventional bank. The conventional bank finds a credit worthy customer and lends at 5% interest. The bank is not particularly concerned about what happens to this money other than that it gets repaid. The customer, on the other hand, has already found a borrower willing to pay 7%. This borrower runs a small credit co-op for students and lends at 10%. One of these students is enterprising enough to lend to his unemployed brother at 15%. Who has just discovered the power of compounding interest and now lends to street vendors at 25%. We could go on. But you get the idea.
28 Islamic Finance Today - July 2020 IFT 29 As we speak, there are poor people paying upwards of 40%...per month! Now obviously we cannot blame conventional banks for everything that happens after they have made the initial loan. But we can blame the power of compounded interest.”
Interest, and the fact that you do not need actual cash to lend money means that the original $10,000 could keep passing hands until we pump out over $100,000 of artificial wealth. Artificial is right. How much actual cash is there? Only $10,000. With interest, we managed to turn $10,000 into much more.
Now what happens if the street vendors go out of business? Or the unemployed brother does not find his job? Or the credit co-op goes bankrupt?
Loans do not get repaid. And if enough people cannot repay their loans, lenders get into all sorts of trouble. This vicious cycle sets off a domino effect of defaults. And imagine that instead of a $10,000 personal loan, it is a million dollar business loan, or a billion dollar World Bank loan. Compounding interest grows so fast that borrowers are often unable to repay. People, economies, and the environment pay the price as we grow more desperate to meet rising debts.
Let us take the example of the Islamic bank. With this $10,000 the Islamic bank only invests in actual assets and services. It might buy machinery, lease out a car, or invest in a small business. But, throughout, the transaction is always tied to a real asset or service.
Islamic Finance Today - July 2020 IFT 30 And this is the central point: we cannot simply “compound” assets and services like we can compound interest-based loans. An asset or service can only have one buyer and one seller at any given time. Interest, on the other hand, allows cash to circulate and grow into enormous sums.
That is the difference between Islamic finance and conventional finance: the difference between buying and selling something real and borrowing and lending something fleeting. In years past we witnessed the most dramatic global financial downturn seen in decades. What began as a housing bubble soon became a sub- prime credit crisis. And what many thought would remain a credit crisis soon spread into a global financial meltdown. It devastated every corner of the world.
And while these events affected most of us negatively, there was one silver lining: people finally gave a serious look at alternative forms of finance. And many people stopped believing that interest could solve all problems.
Understanding what caused these events serves as our starting point for understanding Islamic finance, and how it differs from conventional finance. What conventional finance enables is the ability to sell money when there is no money. To sell assets before there are any underlying assets. And to allow debts to grow unchecked while borrowers become more desperate.
30 Islamic Finance Today - July 2020 IFT 31 Interest creates an artificial money supply that isn’t backed by real assets. The result? Increased inflation, heightened volatility, richer rich, and poorer poor.
Let us look at 3 practical examples that show just how Islamic finance is different from, and better than, conventional finance. And while Islamic finance parts ways with conventional finance on more than just being interest-free, we will focus on interest in this talk.
We look at 3 people in 3 very different, real-world situations: the first is the leader of a developing country: President Obasanjo of Nigeria; the second is Nick, a homebuyer in the UK; and the third is Faisal, an American college student.
Debt-Laden Country: Nigeria
We begin by quoting President Obasanjo who said these words after the G8 summit in Okinawa in 2000: “All that we had borrowed up to 1985 or 1986 was around $5 billion and we have paid about $16 billion yet we are still being told that we owe about $28 billion. That $28 billion came about because of the injustice in the foreign creditors’ interest rates. If you ask me what is the worst thing in the world, I will say it is compound interest.”
It seems unbelievable but, sadly, it is typical. Developing countries start off with relatively small loans and remain saddled with huge amounts of growing debt for generations. And remember, this could be Nigeria, or any other poor country. To give just one other example, during the years leading up to the 1997 Asian collapse, Indonesia’s foreign debt as a percentage of GDP was over 60%. So Nigeria is certainly not an isolated example. There are countless more.
Islamic Finance Today - July 2020 IFT 32 How did borrowing just $5 billion end up in having to pay $44 billion in total? Let’s open up a spreadsheet and find out. For the sake of simplicity we will just grow $5 billion into $44 billion between 1985 and 2000 and see what interest rate we get. It must have been a very high interest rate to get to $44 billion in such a short period of time. So let us start off with 40% per annum.
That still gives us a very high number.
It turns out that to grow $5 billion into $44 billion takes an interest rate of only 15.6%.
Now on the face of it around 15% does not sound exorbitant. It does not seem unfair, and technically it is not even illegal according to international law. In fact, we personally know of banks that charge high-risk credits upwards of 30% interest rates. But every day numerous countries find themselves in the same predicament as Nigeria.
UNICEF estimates that over half a million children under the age of five die each year around the world as a result of the debt crisis. But as we have seen, it is not the debt that is the problem.
It is the compounding interest.
Now how would Islamic finance handle things differently?
Using the $5 billion example, Islamic banks could provide $5 billion of financing for infrastructure, literacy, healthcare, or sanitation programs, to name a few.
32 Islamic Finance Today - July 2020 IFT 33 • An Islamic bank could have arranged for the $4 billion construction of a natural gas pipeline and delivered it to Nigeria for $5 billion using an Istisna.
• Or taken an equity stake in a highway project and shared in profits and losses using Musharakah or Mudarabah.
• Or purchased commodities and sold them at a premium using a Murabaha.
• Or structured a project financing using an Ijarah Sukuk.
These names may sound new, but they are much like conventional equity, trade, and lease-based instruments already familiar to most bankers. Islamic finance, after all, permits legitimate profit.
We are not asking that everything be changed. Just the harmful parts, and eliminating interest would be the first step.
In all of these cases the bank could not have charged more than the initial financing premium. So if the Islamic bank was owed $5 billion, that could never turn into $44 billion or even $6 billion. The debt would have to be fixed.
Let us take another example of how Islamic finance is different from conventional finance. This time let us make it a little bit more relevant to our day-to-day lives.
Nick The Homebuyer Nick has lost his job, his house, and all the money he had spent paying off his mortgage. The property bubble that triggered the global financial meltdown could not have happened if the properties had been financed Islamically. Because a conventional bank merely lends out cash. Legally, it can keep lending this cash over and over. Well above its actual cash reserves.
An Islamic bank, on the other hand, has to take direct ownership of an actual asset. Whether for a longer period in a lease or partnership, or a shorter period in a sale or trade, Islamic finance always limits the institution to an actual asset.
The next time anyone wonders whether Islamic banking is just dressed up conventional banking, ask them to show you a single major consumer bank that co-owns actual properties with their customers.
Islamic Finance Today - July 2020 IFT 34 Of course, there is no excuse for Islamic banks that are Islamic in name only. But if the transaction complies with internationally recognized standards like AAOIFI, for instance, then there is no reason for it to have the many side effects associated with interest-based banking.
To provide just one example of how Islamic banks get directly involved in asset purchases, let us look at how a Diminishing Musharakah works. The word Musharakah refers to a partnership in Islamic finance.
And it is called a Diminishing Musharakah because the bank’s equity keeps decreasing throughout the tenure of the financing, while the client’s ownership keeps increasing through a series of equity purchases. Eventually, the client becomes the sole owner.
If Nick had lost his job with a Diminishing Musharakah, at the very least he would still have an equity stake in an actual property that he could monetize. Pay close attention to this example because this is something you may want to suggest to your own local bank. There is no reason why they cannot do it.
We have kept all the numbers and calculations very simple and straightforward for illustration purposes.
Let us take a $220,000 house. And let us say the customer puts down $20,000 and finances the remaining $200,000 from the Islamic bank. Let us also say that the financing lasts 20 years and the bank sets a 5% profit rate. For the sake of simplicity, we will make it 20 annual repayments.
In the first column in the table given we have the year. In the second column we have the homebuyer’s equity purchase, which is how much the buyer pays every year for buying the property’s actual equity. It is his way of increasing his ownership in the property, while diminishing the bank’s ownership, shown in the third column. The fourth column, called Rent, is what the homebuyer pays the bank for that portion of the property he does not yet own, a number that keeps decreasing as the bank’s share also decreases.
The final column shows what the homebuyer pays in total every year. Let us explain to you how we got these numbers, and how simple it is for most banks to put this together with just the will to take real ownership of an asset.
Going through each column one by one, the homebuyer’s equity purchase of $10,000 is a simple straight line calculation of the $200,000, divided by the number of years for the financing, 20 years. We subtract this $10,000 each year from the bank’s total balance, to get the next column, the bank’s ownership, which, as we see, keeps going down each year until the bank owns none of the property.
34 Islamic Finance Today - July 2020 IFT 35 Table: Nick’s Diminishing Musharakah
Next, we calculate the homebuyer’s rent. This is equal to the bank’s ownership for that period multiplied by the bank’s profit rate. This number also keeps declining each year, because as the bank’s ownership declines, so does the homebuyer’s rent.
Lastly, we calculate the homebuyer’s total annual payment. This is simply the homebuyer’s equity purchase plus his rent. This number also keeps declining each year until the homebuyer eventually becomes the homeowner.
At no time does the homebuyer pay any interest. And, certainly, at no time does any payment compound. The homebuyer just pays for two things: the house, in small payments, little by little. And the rent, for the portion of the house he does not yet own.
This simple structure is something that just about any conventional bank can offer today. It takes a leap of faith for banks accustomed to interest- based lending to suddenly become direct stakeholders in property. But as the growth of Islamic banking shows, these concerns are misplaced.
Call it Islamic finance, ethical finance, or conventional finance, when a bank takes real ownership of an asset, economies do not fall apart like a house of cards.
Islamic Finance Today - July 2020 IFT 36 Faisal the Student Now our final example. Talking about indebted countries and property bubbles may seem removed from our immediate predicament. Everyone knows someone - or personally faces - the biggest issue affecting the ordinary consumer: personal debt.
In the US alone, credit card holders have amassed over $1 trillion of personal debt. And that is just credit cards.
Let us take Faisal’s student loan for example.
His education cost him about $30,000 a year for four years. That is $120,000. And Faisal had no savings to start off with. He got an interest rate of 10%, which is fairly typical for many students, and he began borrowing $30,000 at the beginning of each year. Three years after graduation he began paying off his student loans at the rate of $20,000 per year.
Imagine how long it takes Faisal to pay off his entire loan. It will take him over 25 years. And in the end he spends over $400,000 to pay for his $120,000 education. And that is assuming Faisal keeps his well-paying job. If he is unemployed, the debt just gets bigger.
An Islamic bank, on the other hand, could structure a service-based Ijarah to lease out the university’s credit hours. Faisal ends up paying about 20% or 30% more; but with the interest-based loan, he pays about 400% more.
Islamic finance never can and never will be able to grow Faisal’s debt once it is fixed.
The Principles of Islamic Finance Let us now step back for a moment and ask: so how does Islamic finance make any money?
Take a moment to compare banking in general with Islamic finance.
All conventional banking products can largely be divided into the following four categories: equity, trading, leasing, and debt.
Equity refers to direct ownership, trading refers to buying and selling, leasing refers to giving an asset or service out on rent, and debt refers to providing an interest-based loan
36 Islamic Finance Today - July 2020 IFT 37 Simply put, Islamic finance permits equity, trade, and lease-based transactions, but forbids debt. And in many ways we are already familiar with these kinds of transactions. Here is most of Islamic finance in a nutshell:
• Mudarabah, Musharakah, and Sukuk are all equity based • Murabaha, Salam, and Istisna are trade based • And Ijarahs are lease based
The guiding principles behind Islamic finance transactions are that transactions must: 1. Be interest free 2. Have risk sharing and asset or service backing 3. Have contractual certainty 4. And that all the elements of the transaction must, in and of themselves, be ethical
Let us look at each of these four guiding principles.
First, the transaction must be free of interest. The Islamic ban on interest is not new. For centuries banned by Christians and Jews, the Shariah, or Islamic Law, prohibits paying or earning interest, irrespective of whether it is a soft, development loan or a monthly consumption loan. In fact the Vatican itself has said, “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”
The examples we have seen clearly show the harms of interest, not only to banks and governments but also to individuals. Islam is concerned with the well-being of society, sometimes at the immediate expense of the individual. A single interest-based loan may seem harmless, but an entire economy based on interest can have devastating consequences. The second principle that governs Islamic finance transactions is the element of risk sharing and asset and service backing. The central juristic principle in the Shariah that informs our concept of risk-sharing states: “al ghunm bil ghurm,” meaning “there is no return without risk.”
Bankers know that the concept of risk sharing is common to all equity- based transactions. Islamic finance is no different, where profit and loss distribution is commensurate with investment proportions.
Lending cash on interest is not the kind of risk sharing we are talking about. In a conventional loan the bank does not directly involve itself in how the cash is spent: here is the cash; see you in a few months with some extra cash. Even with a secured loan, in which the bank takes security and gets more involved, there is still no direct equity position. The bank still does not own anything.
Islamic Finance Today - July 2020 IFT 38 An Islamic bank, on the other hand, actually takes a direct equity position, or buys a particular asset and charges a premium through a trade or a lease. It uses risk mitigants, but not without first taking ownership risk.
There must also be contractual certainty. Contracts play a central role in Islam. And the uncertainty of whether a contractual condition will be fulfilled or not is unacceptable in the Shariah. Contractual uncertainty happens when the basic prerequisite or integral of a contract is absent, such as the existence of the subject matter, the fixing of a delivery date, or the agreement on a price. Conventional insurance, interest, futures and options all contain an element of contractual uncertainty and are thus prohibited.
And lastly, Islamic finance transactions must be ethical, which means that there is no buying, selling, or trading in anything that is, in and of itself, impermissible according to the Shariah. Examples include dealing in conventional banking and insurance, alcohol, and tobacco.
This article was adapted from Ethica’s (https://ethica.institute) instructional module introducing Islamic finance. Ethica Institute of Islamic Finance gives everyone the right to forward, read as a speech, or use this article in a public or private forum provided acknowledgement is given.
38 Islamic Finance Today - July 2020 IFT 39 YOUR ONE-STOP ISLAMIC FINANCE ADVISORY
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