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Debate on Islamic Finance by Riazat Butt

Guardian Unlimited looks at Islamic Finance with Junaid Bhatti from the Islamic Bank of Britain, Ed Balls Economic Secretary to HM Treasury, Tony Levene from the Guardian, and Sharia-sceptic Dr Mohammed Saleem.

> Click here to download the debate now.

Principles in Islamic Finance

Islamic Bank

Islamic Banking has the same purpose as conventional banking except that it claims to operate in accordance with the rules of shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba┬┤ (interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).

Islamic Banks have grown recently in the Muslim world but are a very small share of the global banking system. microlending institutions such as Grameen Bank use conventional lending practices, and are popular in some Muslim nations, but are clearly not Islamic banking.  In theory, Islamic banking should be synonymous with reserve banking, with banks achieving a 100% reserve ratio. However, in practice, this is rarely the case.  Finally, Islamic banking is restricted to Islamically acceptable deals, which exclude those involving alcohol, pork, gambling, etc. Thus ethical investing is the only acceptable form of investment, and moral purchasing is encouraged.

Shariah Advisory Council

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to establish Shariah advisory committees/consultants to advise them and to ensure that the operations and activities of the bank comply with Shariah principles.

Islamic Mortgage

In an Islamic Mortggage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. However, the fact that it is profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is Ijara wa Iqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

Islamic Business Finance

There are several other approaches used in business deals. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between captial and labour reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

Islamic laws on Trading

The Quaran prohibits gambling (games of chance involving money). The Hadith, in addition to prohibiting gambling (games of chance), also prohibits bayu al-ghararg (trading in risk, where the Arabic word gharar is taken to mean "risk").

The Hanafi Madhah (legal school) in Islam defines gharar as "that whose consequences are hidden." The Shafi legal school defined gharar as "that whose nature and consequences are hidden" or "that which admits two possibilities, with the less desirable one being more likely." The Hanbali school defined it as "that whose consequences are unknown" or "that which is undeliverable, whether it exists or not." Ibn Hazn of the Zahini school wrote "Gharar is where the buyer does not know what he bought, or the seller does not know what he sold.'

The modern scholar of Islam, Professor Mustafa Al-Zarqa, wrote that "Gharar is the sale of probable items whose existence or characteristics are not certain, due to the risky nature that makes the trade similar to gambling." There are a number of Hadith who forbid trading in gharar, often giving specific examples of gharhar transactions (e.g., selling the birds in the sky or the fish in the water, the catch of the diver, an unborn calf in its mother's womb, the sperm and unfertilized eggs of camels, etc.). Jurists have sought many complete definitions of the term. They also came up with the concept of yasir (minor risk); a financial transaction with a minor risk is deemed to be halal (permissible) while trading in non-minor risk (bayu al-ghasar) is deemed to be Haram.

What gharar is, exactly, was never fully decided upon by the Muslim jurists. This was mainly due to the complication of having to decide what is and is not a minor risk. Derivatives instruments (such as stock options) have only become common relatively recently. Some Islamic banks do provide brokerage services for stock trading and perhaps even for derivatives trading.



Islamic Mortgages Info

Islamic Finance podcast

Mohammed Amin of Price Waterhouse Coopers, has recorded a pod cast on Islamic Finance; Mohamed gave a talk in London last year regarding its taxation (August 2006). To share this with readers, he has recorded the presentation in audio format.

> Click here to download this audio broadcast.


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