www.EthicaInstitute.com CIFE™ STUDY NOTES www.EthicaInstitute.com ABOUT ETHICA www.EthicaInstitute.com DOWNLOAD BROCHURE HERE >> About Ethica Institute of Islamic Finance www.EthicaInstitute.com About Ethica Institute of Islamic Finance www.EthicaInstitute.com www.EthicaInstitute.com About the Certified Islamic Finance Executive™ (CIFE™) www.EthicaInstitute.com About the Certified Islamic Finance Executive™ (CIFE™) www.EthicaInstitute.com DOWNLOAD BROCHURE HERE >> About the Certified Islamic Finance Executive™ (CIFE™) www.EthicaInstitute.com CIFE™ STUDY NOTES A User’s Guide to Ethica’s Certified Islamic Finance Executive™ Program Important Note: The following CIFE™ Study Notes are an accompaniment to the online training modules available at Ethica and are not meant to replace the blended learning experience of the complete Certified Islamic Finance Executive™ program. About the Certified Islamic Finance Executive™ (CIFE™) www.EthicaInstitute.com CIFE01: WHY ISLAMIC FINANCE? What makes Islamic finance different from conventional finance? And what makes it better? We look at 3 real- world examples and find out. We also introduce you to the 4 principles that guide Islamic finance transactions. The difference between Islamic finance and conventional finance is the difference between buying and selling something real and borrowing and lending something fleeting. Conventional banking transactions are interest based. Islamic bank transactions are asset or service backed. An asset or service cannot be compounded like an interest based loan. An asset or service can only have one buyer or seller at any given time, whereas interest allows cash to circulate and grow into enormous sums. Interest creates an artificial money supply that isn’t backed by real assets resulting in increased inflation, heightened volatility, rich getting richer, and poor getting poorer. Nigerian President Obasanjo – Example Nigeria took a $5 billion loan in 1985 and paid it off as $44 billion in 2000 as a result of compound interest. How would the Islamic bank manage such a developing country’s need? • 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. About the Certified Islamic Finance Executive™ (CIFE™) www.EthicaInstitute.com Nick the Homebuyer – Example In 2009 Nick 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. How could Islamic finance have fulfilled Nick’s need for a home? Based on a Diminishing Musharakah. Musharakah refers to partnership. In a Diminishing Musharakah, 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. At no time does the homebuyer pay any interest and 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 doesn’t yet own. Faisal the Student – Example Faisal took a student loan. His university cost him $120,000 for four years. 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 a year. It took him 25 years to pay off his loan and he ended up paying over $400,000. How would an Islamic bank fulfill Faisal’s need? An Islamic bank 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’s fixed. Islamic Finance Essentials All banking products can largely be divided into the following 4 categories: 1. Equity 2. Trading 3. Leasing 4. Debt CIFE™ Study Notes www.EthicaInstitute.com Some important Islamic finance transactions: • Equity based - Mudarabah, Musharakah, and Sukuk • Trade based - Murabaha, Salam, and Istisna • Lease based - Ijarahs Islamic banking transactions must: 1. Be interest free. 2. Have risk sharing and asset and service backing: Based on the Islamic concept of “no return without risk.” An Islamic bank 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. 3. Have 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. 4. Be ethical: There is no buying, selling, or trading in anything that is, in and of itself, impermissible according to the Shariah for instance dealing in conventional banking and insurance, alcohol, and tobacco. CIFE™ Study Notes www.EthicaInstitute.com CIFE02, 03, 04: UNDERSTANDING MUSHARAKAH – ISLAMIC BUSINESS PARTNERSHIPS You have heard of joint-stock companies. Now learn about the Islamic variation. We look at Musharakah, the Islamic business partnership where partners pool together capital, expertise or goodwill to conduct business or trade. We look at the basic features of a Musharakah and its types, their mode of operation, duration and the various forms of capital contribution. We discuss the management of the Musharakah business and take you through some practical applications of how Islamic banks use Musharakah. We also look at profit and loss sharing ahead of the subsequent module's profit calculation exercises. We complete our discussion on general aspects of Musharakah, including how banks handle negligence, termination, and constructive liquidation. We round our discussion with some practical examples of Musharakah calculation, a quick review of financial statements and how exactly profit gets calculated. A Musharakah is a partnership that is set up between two or more parties usually to conduct business or trade. It is created by investing capital or pooling together expertise or goodwill. Partners share profit based on ownership ratios and to the extent of their participation in the business and share loss in proportion to the capital they invest. Profit cannot not be fixed in absolute terms such as a number or percentage of invested capital or revenue. CIFE™ Study Notes www.EthicaInstitute.com Types of Musharakah: • Shirkah tul Aqd • Shirkah tul Milk Shirkah tul Aqd is a partnership to enter into a joint business venture and trade. Partners enter into a contract to engage in a defined profit seeking business activity. Shirkah tul Milk is a partnership in the ownership of property or assets for personal use. Every Shirkah tul Aqd has a Shirkah tul Milk imbedded in it, namely joint ownership of assets and property. Differences between Shirkah tul Aqd and Shirkah tul Milk 1. Shirkah tul Aqd is a direct contract of partnership in a business or income generating activity whereas Shirkah tul Milk comes indirectly through contracts or arrangements unrelated to production or income generation. 2. Shirkah tul Milk is a partnership of joint ownership as opposed to a commercial venture (Shirkah tul Aqd). It may serve as source of income for one party but not for both. Types of Shirkah tul Aqd: • Shirkah tul Wujooh: Partnership where subject matter is bought on credit from the market based on a relationship of goodwill with the supplier. • Shirkah tul Aa’mal: Partnership in the business of providing services. There is no capital investment, instead partners enter into a joint venture to render services for a fee. • Shirkah tul ‘Amwaal/Shirkah tul ‘Inaan: Partnership between two or more parties to earn profit by investing in a joint business venture. Musharakah Duration Ongoing Musharakah: Most common form also referred to as open-ended or permanent. Partnership where there is no intention of terminating or concluding the business venture at any point for instance equity participation. Partners may exit the business at any point they want. This is usually done by the remaining partner(s) purchasing the share of the individual exiting the Musharakah. Temporary Musharakah: Partnership created with the intention of terminating it at a given time in the future at which point Musharakah assets are sold and distributed along with any remaining profit on a pro-rata basis. CIFE™ Study Notes www.EthicaInstitute.com It is used to meet working capital needs of businesses, other examples being private equity followed by planned exit. Musharakah Capital All Shariah–compliant items of material value may be used as capital in a Musharakah. It may be in the form of cash or it may be in kind, for instance contributing assets to the business in which case it is necessary to ensure the assets are valued at the time of Musharakah execution. Partners’ capital investment ratio must be determined at Musharakah inception or before the business generates profit. In case of a Musharakah investment in different currencies, partners must agree upon the numeraire, i.e. one particular currency to serve as the standard of value in the business which is usually the currency of the country where the business is located.