One of the most prominent aspects of Islam is that it attempts to moralize every walk of life. All social institutions (religious, political, economic, educational, recreational and legal) are structured in such a way that the enabling societal conditions are provided where an individual’s as well as a society’s collective advancement is ensured within strong moral precepts. The same is the case with economic institution of Islam that seeks equitable distribution of resources, end of economic exploitation, mainstreaming of marginalized segments of society and elimination of poverty with its moralized fundamentals of economy and finance.
Islamic finance refers to the provision of financial services as per Islamic jurisprudence (Shariah). Shariah bans all forms of Riba (interest) whether on commercial loans or on personal ones, gambling and short sale, and also prohibits all business activities that maybe harmful to society such as trade of alcohol and other such drugs. Fair treatment and sanctity of honour are, in principle, important pillars of the Islamic finance. The whole edifice of Islamic finance has been underpinned by the real economic activities and it implies that investments are made in tangible properties and businesses, and the risk associated with investments is shared by all parties involved.
As per Islamic viewpoint, money is only a way of determining the value of something; it has no value itself. So, generating more money by simply saving money in banks or lending it to someone on interest is not allowed. Islamic banks are funded by non-interest current account as well as profit-sharing investment accounts where the investor receives ex-post profit (based on actual results rather than forecasts) that is determined by the profitability of banks or the pool of assets financed thereby. Traditional means of earning money in conventional banking systems like loans, mortgage and charging interest on them are avoided in Islamic finance. The Shariah-compliant banks use the depositors’ money to acquire assets and share any profit earned thereupon with the depositor. So, Islamic banks do not engage in lending but these banks deal with sales, lease, profit-and-loss-sharing financing and fee-based services. All transactions, transfers, ownerships and purchases are made in real goods among the parties and the return hinges on the profitability of underlying transactions. The principal amount is not guaranteed and instead of interest, the debtors provide predetermined and periodic payments to the banks based upon expected profits earned from investments.
Islamic finance reveals itself in many different forms and hues. Broadly speaking, economic activities based on Islamic finance can be classified into three categories:
1. Debt-like financial products such as sales that could be with markup, or deferred payments, are known as Murabahaha. These products can be in the form of purchases with deferred delivery of products which is called as Salam for basic products and Istisna for manufactured products. Sukuk bonds can also be placed under this category of which Ijara is the most common type that is Islamic finance’s version of leasing. Ijara is asset-based leasing in which the issuer transfers the ownership of some tangible assets to bondholder and pledges to give predetermined rent to the bondholder until the maturity of bond.
2. Another category is profit-and-loss-sharing financial products. These are further of two types: (a) Profit-sharing and loss-bearing known as Mudarbah; and (b) profit-and-loss sharing known as Musharkah. Under Mudarbah arrangement, the financier (whether bank or investor) provides capital and beneficiary provides labour and skills. In this arrangement, profit is shared and loss is borne by the financier. As name indicates Musharakah is arrangement under which two parties have equity-like financing of projects and they share profits and losses.
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