There has always been a demand among Muslims for financial products and services that conform to Shariah (Islamic Law). The development of viable alternatives to conventional finance increasingly enables Muslims with the estimated 1.6 billion Muslims worldwide, it’s ripe for growth potential to participate in the financial world without violating their Islamic principles and without bearing the economic penalty that comes from non-participation, especially with the recent growth of oil prices. Here are the following facts about Islamic Finance.
Islamic banking can be considered banking with a conscience. Islamic banks each have a Shariah board made up of Shariah scholars as well as financial experts who are responsible for determining what activities are and are not Shariah-compliant. 1
Islamic banking is based on two main financial principles. Firstly, investment is to be made in the private sector through interest-free financing. Secondly, the development of financial instruments is to be done on the basis of profit and loss sharing as well as sharing risks. 2
Islamic laws strictly prohibit investments connected with gambling, liquor or tobacco.
Islamic banks must conform to Sharia law and, as a result, to the following six principles:
- They must not allow predetermined loan repayments to become interest (riba) – the receipt and payment of interest is strictly prohibited.
- The sharing of profits and losses must be at the heart of the Islamic banking system.
- All financial transactions must be asset-backed. In other words, making money out of money isn’t acceptable in Islamic finance.
Speculative behaviour is forbidden (and so options and futures are prohibited in Islamic finance). 4
The word riba in Islamic law means an addition over and above principal. So riba is the addition in the amount of the principal amount of a loan according to the time for which it’s loaned and the amount of the loan. In other words, it’s the equivalent of interest, but financial systems based on Sharia law strive to eliminate the payment and receipt of interest in all forms. 5
A range of modern interpretations apply as to why riba is forbidden, although they’re strictly secondary to the religious underpinnings.
a hawala can be a bill of exchange, cheque, draft or promissory note. Hawala is a mechanism that can be used in order to set up international accounts by book transfer. To a large extent, this approach removes the need to transfer physical cash. Technically, debtors pass on the responsibility of payment of their debt to a third party who owes the former a debt; hence, the responsibility of payment is shifted to a third party. This arrangement is unique because no form of financial instrument is exchanged; the transaction takes place entirely on the honour system (a system based on trust, honour and honesty). Trust and the extensive use of connections such as family relations are the components that make it completely different from other remittance systems.6
Islamic banks are strictly forbidden to charge interest. Instead, the concept of profit and loss sharing comes into play. Islamic banks don’t charge interest but instead participate in the yield that results in the use of funds. Depositors also share in the bank’s profits, which are determined in accordance with an agreed ratio. Hence, a partnership exists between the Islamic bank and its depositors and also between the bank and its investment clients. 7
Islamic banks can’t make money with money, because under Sharia law money is only a medium of exchange – a way of defining the value of something – and it has no value in itself. Therefore, money isn’t allowed to generate more money by being put in a bank or lent to someone else.
When a Western bank or finance house invests in a project, the investor (the bank or finance house) is assured of a predetermined rate of interest and the investee bears all risk. The investor receives a predetermined return regardless of whether the project succeeds or fails.
This situation doesn’t apply in Islamic banking, which promotes risk-sharing between an investor and an investee: the unjust distribution of risk that occurs in Western banking is prohibited. In Islamic banking, the investor and the investee share the results of the project in an equitable way. Where a project makes a profit, both parties share in this profit in predetermined proportions. On the flip side, if a project makes a loss, the investor bears the loss by way of no repayments, with the investee bearing the loss by receiving no wage or salary. 8
As the Islamic finance market begins to experience full-grown, investors and banks are demanding new products and new structures that are complaint with Shariah principles. But while the products must be often syndicated with Shariah scholars, English and American financial lawyers are finding ways of making Islamic products work. This syndication allows the Muslims who recognize Shariah law to use and benefit from the Shariah-compliant financial tools at Western banks or companies. Although there have been innovative initiations by Islamic financial institutions in several fields, like information technology, industrial projects, and even providing insurance against political risk, the industry still needs more innovative and sophisticated financial instruments taking advantage of western financial experience to streamline and standardize Shariah-compliant products.
David Isaiah Angway is a Registered Financial Planner, Chartered Wealth Advisor and a financial consultant for IT-BPO-Banking, HealthCare Industry and Manpower Agencies. He is a conference speaker and was featured multiple times in ABS-CBN News Channel show called On the money, Bloomberg TV Philippines First Up. He also writes for BusinessMirror, Rappler.com, and MoneySense magazine. He is a licensed nurse and a former Senior Fraud Specialist of the largest bank in the world, JP Morgan Chase & Co. He is the CEO and founder of WinLongTerm Financial Consultancy, that helps organizations retain their top key employees such young urban and educated millennial (Gen Y). It sets and achieves their long-term financial goals by empowering them through behavioral finance.