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An Introduction to Islamic Finance
Islamic finance refers to financial services which are compliant with the principles of Islamic sharia law. These services are available in Muslim countries, or to Muslim communities living in non-Muslim countries.
Sharia law governs many aspects of religious and civil life in Islam, but in relation to finance this has two clear implications. Sharia law declares all forms of interest as ribaa meaning usury, or unethical and exploitative. As such, financial services such as mortgages and personal loans offered by standard banking services are in contradiction to sharia law and therefore considered to be haraam, or forbidden. Sharia law also forbids Muslims to invest in companies which deal in products considered to be haraam, including pork and alcohol.
Islamic finance is particularly concerned with the notions of risk and uncertainty. In Islamic finance this is known as Gharar, which holds multiple connotations of risk, uncertainty, deceit and hazard. Though not as strictly defined as ribaa, it is understood that Gharar is of equal importance in outlining financial practice in accordance with Islamic law. In practical terms, Gharar means avoiding unnecessary risk in investments, ensuring that a cost benefit analysis is in favour of benefit, and that parties have complete knowledge of the terms of exchange in advance of a deal. Limited levels of Gharar are accepted in the case of forward contracts and instalment payments, if on-the-ground realities demand such transactions, so long as the payment and delivery of the service is secured.
Islamic finance is characterised by a number of contracts designed to comply with sharia law. One such contract is the Mudarabah Contract, in which two parties are involved; one party contributes the capital and another party contributes 'personal effort' such as supplying labour or management skills and expertise. The Contract has been likened to the relationship between a silent partner and a working partner, or a profit-and-loss sharing contract. If the enterprise makes a profit, that profit is shared between the invested parties according to pre-agreed terms. If the enterprise makes a loss, the financial loss is borne by the investor of the capital, but the investor of the 'personal effort' receives no monetary compensation for his labour or time. Mudarabah Contracts are limited by a specific time period and rarely continue indefinitely. The investor of the capital can be either an Islamic bank, or an independent investor who uses the bank as an intermediary to transfer funds.
Musharakah (or Musharaka) Contracts are another form of Islamic finance. Musharakah translates as partnership or sharing, with such contracts seeing the investment of capital from two or more parties. Islamic banks can be one of these parties. Unlike Mudarabah Contracts however, both profit and loss are shared by the invested parties in accordance with the proportion of their initial investment. Musharakah Contracts act as an alternative to traditional banking methods where the investor charges interest, and instead offers the investor a direct proportion of the profits achieved. Unlike traditional lending however, the investor also shares in the losses.
Salam Contracts, otherwise known as Bai Salam allow advance payments for goods and services while remaining in compliance with sharia law. Under this contract the seller is paid in full at the time of the contract, in exchange for agreeing to provide these goods and services at an agreed future date. The quantity and quality of these goods must also be agreed upon in advance, and the buyer reserves the right to refuse the delivery of the products if these standards are not met. It could be argued that Salam Contracts represent a form of debt and are thus in contradiction to sharia law, and so the rules associated with Bai Salam must be strictly adhered to. Among these rules are that the Contract must clearly specify the date and place of delivery, the product must be fungible (mutually interchangeable), and payment must be made in full at the point of sale.
These contracts and Islamic finance as a whole have seen fast-paced growth since their popularisation in the 1970s. According to research conducted by Ernst & Young in 2014, it is estimated that Islamic banking assets grew at an annual rate of 17.6% between 2009 and 2013, and will continue to grow. It is estimated that the global industry holds total assets of around $2 trillion, with countries like Iran, Saudi Arabia and Malaysia accounting for large proportions of these assets.
Know Your Subject Ltd provides learning resources for the ACCA & CIMA professional accountancy syllabus.
Please visit our website http://www.knowyoursubject.com to download our free student interface and read about our new mobile revision applications.
Twitter: @knowyoursubject
Article Source: http://EzineArticles.com/expert/Martin_Tudge/2196785
Article Source: http://EzineArticles.com/9351267
Sharia law governs many aspects of religious and civil life in Islam, but in relation to finance this has two clear implications. Sharia law declares all forms of interest as ribaa meaning usury, or unethical and exploitative. As such, financial services such as mortgages and personal loans offered by standard banking services are in contradiction to sharia law and therefore considered to be haraam, or forbidden. Sharia law also forbids Muslims to invest in companies which deal in products considered to be haraam, including pork and alcohol.
Islamic finance is particularly concerned with the notions of risk and uncertainty. In Islamic finance this is known as Gharar, which holds multiple connotations of risk, uncertainty, deceit and hazard. Though not as strictly defined as ribaa, it is understood that Gharar is of equal importance in outlining financial practice in accordance with Islamic law. In practical terms, Gharar means avoiding unnecessary risk in investments, ensuring that a cost benefit analysis is in favour of benefit, and that parties have complete knowledge of the terms of exchange in advance of a deal. Limited levels of Gharar are accepted in the case of forward contracts and instalment payments, if on-the-ground realities demand such transactions, so long as the payment and delivery of the service is secured.
Islamic finance is characterised by a number of contracts designed to comply with sharia law. One such contract is the Mudarabah Contract, in which two parties are involved; one party contributes the capital and another party contributes 'personal effort' such as supplying labour or management skills and expertise. The Contract has been likened to the relationship between a silent partner and a working partner, or a profit-and-loss sharing contract. If the enterprise makes a profit, that profit is shared between the invested parties according to pre-agreed terms. If the enterprise makes a loss, the financial loss is borne by the investor of the capital, but the investor of the 'personal effort' receives no monetary compensation for his labour or time. Mudarabah Contracts are limited by a specific time period and rarely continue indefinitely. The investor of the capital can be either an Islamic bank, or an independent investor who uses the bank as an intermediary to transfer funds.
Musharakah (or Musharaka) Contracts are another form of Islamic finance. Musharakah translates as partnership or sharing, with such contracts seeing the investment of capital from two or more parties. Islamic banks can be one of these parties. Unlike Mudarabah Contracts however, both profit and loss are shared by the invested parties in accordance with the proportion of their initial investment. Musharakah Contracts act as an alternative to traditional banking methods where the investor charges interest, and instead offers the investor a direct proportion of the profits achieved. Unlike traditional lending however, the investor also shares in the losses.
Salam Contracts, otherwise known as Bai Salam allow advance payments for goods and services while remaining in compliance with sharia law. Under this contract the seller is paid in full at the time of the contract, in exchange for agreeing to provide these goods and services at an agreed future date. The quantity and quality of these goods must also be agreed upon in advance, and the buyer reserves the right to refuse the delivery of the products if these standards are not met. It could be argued that Salam Contracts represent a form of debt and are thus in contradiction to sharia law, and so the rules associated with Bai Salam must be strictly adhered to. Among these rules are that the Contract must clearly specify the date and place of delivery, the product must be fungible (mutually interchangeable), and payment must be made in full at the point of sale.
These contracts and Islamic finance as a whole have seen fast-paced growth since their popularisation in the 1970s. According to research conducted by Ernst & Young in 2014, it is estimated that Islamic banking assets grew at an annual rate of 17.6% between 2009 and 2013, and will continue to grow. It is estimated that the global industry holds total assets of around $2 trillion, with countries like Iran, Saudi Arabia and Malaysia accounting for large proportions of these assets.
Know Your Subject Ltd provides learning resources for the ACCA & CIMA professional accountancy syllabus.
Please visit our website http://www.knowyoursubject.com to download our free student interface and read about our new mobile revision applications.
Twitter: @knowyoursubject
Article Source: http://EzineArticles.com/expert/Martin_Tudge/2196785
Article Source: http://EzineArticles.com/9351267
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