Chapter 28 !

Islamic Finance

Next Exam !

Monday March 17 Chapters 28 and 29

Riyadh Financial District

Holy Quran SunnaShariah - “Sacred Law”

Islamic Finance

Ebdat Muamalat

Avoid Riba and Gharar

Riba - UsuryInterest-based lending

where borrower repays more than amount borrowed to reflect

time delay in repayment

GhararExcessive uncertainty

and ambiguity about an outcome

!

Gambling and Insurance

HaramForbidden practices

!

No interest No selling what you do

not own No selling of debts

Interest Prohibited

Profit and Loss Sharing Permitted

Haram - Prohibited Interest

Halal - Permitted Profit and Loss Sharing

Avoid RibaNo interest elements

Null and void

Different cultures have different definitions of fairness and justice and

what is unfair and unjust

Islamic definition of fairness and justice

Money Profit Risk

Interest

Argument1. Can only charge rent on something that is a commodity !2. Unfair to charge rent on something that is not a commodity !3. Money is not a commodity. !4. Therefore money cannot be rented !5. Rent on money is called interest !6. Therefore cannot charge interest

Avoid Gharar

Gambling - Zero Sum Game

!

Seller should own what they intend to sell

Objectives

Maximize profit and wealth

!

Spread prosperity

Islamic Finance Money does not have

intrinsic value !

Just a measure of value or medium of exchange

Islamic Finance Must have an asset

involved in the exchange !

No money for money

Participatory-type finance

Share profit and loss Share risk

!

Equity position Debt position

Zakat - Religious Tax

2.5 Percent on profits !

Poor, orphans, charity Finance projects

Operations

Islamic Shariah - Interpreted

Non-Islamic Secular - Elected

Interest ChargingIslamic

Not allowed Profit and loss sharing

Non-Islamic Allowed

Fixed and variable

Interest on DepositsIslamic

Not allowed May share in profits

Non-Islamic Allowed

Interest plus principal

Risk Sharing

Islamic Must share risk

Non-Islamic May share risk

Penalty on Default

Islamic Not allowed to charge

Non-Islamic May charge

Gharar

Islamic Forbidden

Non-Islamic Allowed

Customer Relationship

Islamic Partner and Investor

Non-Islamic Partner and Investor Creditor and Debtor

Shariah Supervision

Islamic Requires Board

Non-Islamic No Board

Islamic Banks

Maximize shareholder wealth

!

Develop society

Source of Funds

Shareholders Depositors

Deposits

Current Savings

Investment

Hiba

A non-predetermined return paid

!

Gift

Current Deposit Accounts

Receive funds on demand Issue checks

No guarantee of return Bank may give Hiba

Savings Deposit Accounts

Wadiah Must get permission to

use for loans Bank may give Hiba

Investment Deposit AccountsMudarabah

Specific time period Profit and loss sharing based

on predetermined ratio Could lose deposit

Islamic Profit and loss sharing system

!

Non Islamic Profit and loss sharing system

interest-based system

Equity Financing

Musharakah !

Mudarabah

MusharakahPartnership

All contribute capital Profit shared on prior agreement

Only lose invested capital Charge a fee if manage

Project pays profit share to bank Entrepreneur pays bank capital

MudarabahPartnership

Bank contributes capital Entrepreneur contributes work

Profit shared on prior agreement Bank bears all capital losses

Asset Financing

Must own before reselling !

Murabahah Salem

Ijarah Leasing

Murabahah

Bank buys the asset Resells to customer

Price includes cost plus markup profit

Full disclosure transparency Customer pays installments or lump

sum at the end

SalemBank buys the asset today for

delivery in the future !

Agriculture !

Buyer responsible for delivery

Ijarah LeasingUsufruct: temporary use and enjoyment

of a property !

Bank (Lessor) buys the asset and rents to client (lessee)

!

Client may return or receive asset at the end of the term

!

Sukuk - Islamic BondsRegular bonds not permitted

Interest and reselling debt prohibited Investor owns a proportionate

undivided share of the asset !

Ownership equity position not a debt position

!

No guarantee or fixed return

Takaful - Islamic InsuranceDistribute losses among participants

Participants pool funds No insurer-insured relationship

!

Operator manages account fund Participants pay premiums to create fund

Operator pays damages out of funds !

Operator can charge an administrative fee

FutureDifferent views and interpretations

Evolving No uniform consensus

!

Four schools of thought: Shafi’i, Maliki, Hanafi,

and Hanbali