Introduction
Muslims in the last few decades have been restructuring their social, economic and political lives around Islamic principles. The Muslims believe that the western dominance both on their socio-economic and political fields has deprived them off their divine direction. Due to this believe, the modern Islamic society is trying to organize its life in tandem with the Islamic teachings.
According to Asutay (2007), the economic realm was one of the biggest challenges since the purpose was to reform the sector to suit their Islamic Shari’ah teachings. Drawing from El Qorchi (2005), the entire financial system revolves around making interests so the herculean task was to restructure the whole system to an interest free basis. People with poor or no understanding of the Shari’ah laws would feel that the abolishment of interest in the sector would convert the entire financial system into charitable organizations, rather than commercial entities.
For instance, the Shari’ah law interest free loans cover the cooperative and charitable operations and not commercial transactions. Gait & Worthington (2008) assert that the Islamic banking has grown at a faster annual rate of 10% to 15% in the past decade. Initially, it was concentrated within the GCC region but has lately expanded to other Muslim and non-Muslim regions. The stated example shows that the Islamic finance has a total different setting as shall be depicted in the research paper.
Principles and Characteristics of Islamic Finance
The paper shall analyze the Islamic finance in line with Ilias (2008), who propagates that the Islamic finance is based on a ban on interest, uncertainty (gambling), faithfulness to risk & profit sharing, banking on ethical stance, which promotes society and asset backing.
Prohibition of Interest (Riba)
According to Ahmed (2007), the direct methods of finance involve a distinction between the acceptable interest and the one considered usurious interest. The Islamic law prohibits any form of interest since it is considered as earned from usury activities. The term “Riba” means “an excess” and the Qur’an and literature of hadith, it is the gain obtained from the exchange of two commodities in distinct quantities.
To add on, it is the charge for the period of indebtedness from the use of someone’s money (Youself, 2004). Riba is used unacceptable if it is linked to any unjustifiable increment of capital on loans or even sales. Additionally, any positive rate attached to any principal upon maturity regardless of the performance of the investment is regarded as riba and is not allowed.
Youself (2004) further connotes that within the Islamic financial system, creation of debts comes through direct lending and asset borrowing, which are real items. Riba contradicts the normal financial system since a debtor is required to pay the interest accrued, irrespective of profit or loss made from the extended finance. However, the Islamic principles link performance to returns such that the parties share profits or losses. To add on the Shari’ah prohibits usury since it is a form of exploitation and impedes economic development.
Prohibition of Uncertainty (Gharar) and Gambling (Maysir)
According to Jobst (2007), Gharar is a problem caused by lack of clarity regarding the subject matter or price of a contract. For instance, a party signing a contract without prior clarity about its importance, payment made by one of the parties to the contract, albeit under some conditions and the cost of the contract being unclear when putting ones signature. According to Shanmugam & Zahari (2009), Gharara means selling an item, which is not present at hand or selling something whose “Aqibaha,” (Consequence) is unknown, or hazard, which one does not know if it shall happen.
Any contract or sale of business that shows signs of Gharar are prohibited. However, whereas uncertainty cannot completely be avoided, too much of it will render a transaction “Haram.” For instance, a religious perspective can be selling of fish while still in water or selling of a bird that is still on its wings. The modern financial products can be futures, options and derivatives.
Hoepner, Rammal & Rezec (2011) connotes that such principals assisted the Islamic financial system in that it was least affected by the global recession. In my perception such financial system are assistive in sustaining the economy where people live in poverty and there is some level of illiteracy. The Gharar and Maysir principles are effective especially to illiterate people who would wish to own property but do not understand the terms of the law. In such a stance, both principles act as a way of protecting people from being conned through unfair dealings.
Ethical Investments that Promote Society
Drawing from Ahmed (2009), the Islamic finance prohibits activities or investment in industries that are unacceptable according to the Qua’anic laws. The given products are regarded as Haram as opposed to products, which are Halal; regarded acceptable by the Shari’ah laws. The haram activities are perceived as detrimental to the society’s divine well-being. In the conventional financial system, any profitable activity is advisable and can receive funding from any financial institution, which is different from the Islamic finance.
The haram activities include selling pork meat, armaments, trading in alcoholic drinks and trading with organizations that screen an entrepreneur from the stated and other haram operations. Bley & Kuehn (2004) opine that even banking institution that trade with companies engaging in haram operations are perceived as doing illicit activities. Bley & Kuehn further assert that trade involving speculative items, for instance, money, silver and gold are also unacceptable.
Asset-backed Financing
Wilson (2009) asserts that the Islamic financing is based on asset financing whereby money is not regarded as a subject matter of trade, except in exceptional cases. Conversely, the conventional financial systems in a capitalistic are mounted to the concept of money and monetary papers only.
Due to such models, they are prohibited, in most countries, from trading in goods and accumulating inventories. Bley, & Kuehn (2004) connotes that the Islamic financial system regards money as an intrinsic utility and only a medium of exchange. Each unit of money is equal to the other unit of the same value therefore, making profits through the exchange of these units is prohibited. Making profit comes through selling of commodities with intrinsic value or exchanging different currencies one for another.
Thus, financing in Islam is mounted on illiquid assets, which create real assets and inventories. Ilias (2008) provides the real forms of financing according to the Shari’ah law, which are “musharakah, mudarabah, salam and istisna.” When the financer contributes money in line with the above-mentioned instruments, they are bound to be converted into items possessing intrinsic value hence, profits are generated through the sale of these values. Albeit istisna financing revolves around the manufacture of real assets as a return, to which the financier earns profit.
Islamic Finance Regulation
Wilson (2009) opines that any financial institution seeking to offer Shari’ah compliant products should have a Shari’ah supervisory board. The board is tasked with reviewing the institutions financial practices, which should comply with Islamic principles. Additionally, International institutions have been established to promote consistency in Islamic Finance. For instance, Islamic Financial Boards (IFSB), which develops standards for supervision and regulation.
Conclusions
Thus, the Islamic finance has brought a positive change in the conventional financial sector. The system has brought a lot of changes in the modern financial system, which to some extent, best suits the economy. The Islamic financial system is unique in its way such that it is guided by the Qur’anic principles. The system prohibits acts of riba on some of its financial services, which is different from the modern capitalistic financial sector was built on the foundation on interest.
The Islamic financial system prohibits certain acts of gharar or Maysir, which are considered haram. Such acts are permissive in some countries however, they have streamlined the GCC economy due to their restrictions on exploitation and the negative impacts it brings to the economy. Finally, the Islamic finance has prevented the culmination of investments that lack ethical backing and regarded as detrimental to the society. Finally, asset-backed financing within the Islamic finance does not regard money as an asset of trade. The “musharakah, mudarabah, salam and istisna.” are the only forms of assets for trading purposes.
References
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