Islamic Finance, the facts.
by Wong Teck Kow, Legal Counsel, iFast Financial Pte Ltd
What are the basic principles of Islamic banking?
Islam is the relationship between man and God. It is also a system of beliefs. Justice, equity, fairness and morality are values which underpin the entire Islamic way of life. These beliefs are governed by Islamic law, generally referred to as Shari'ah. Many financial institutions have a religious board or a Shari'ah adviser to ensure compliance with the principles of Shari'ah and to provide an opinion, or fatwa, when required. These principles include:
The charging of interest, or riba, is strictly prohibited. Any return on money employed should be linked with the profits of a business. The concept of riba can also be described in terms of a prohibition of unfair exploitation by one party, who owns a product that includes money or capital, of another party who wishes to acquire the product.
Shari'ah does not permit speculation or gambling, or maisir. As a result, many Islamic financial institutions are unable to enter into derivative transactions such as swaps, futures, options or contracts that insure for a profit.
Investments involving certain products, such as pork, alcohol or armaments, and activities such as gambling are prohibited. Islamic institutions may (depending on the view taken by Shari'ah committees) encounter difficulties with investments in businesses such as hotels and the entertainment industry.
Profit cannot be assured and an Islamic financial institution must assume at least part of the risk of a given transaction. There can be no guarantee of a fixed return. Equally, depositors with Islamic institutions may not invest on the basis of a guaranteed return. However, taking security is permitted to safeguard against negligence, wilful wrong doing or breach of contract by parties to the contract.
The existence of uncertainty, or gharar, in a contract is prohibited as it requires the occurance of an event which may not occur. When entering into a contractual relationship, there must be full disclosure by both parties. Any transaction where the subject matter, price or both not determined in advance, will be viewed with suspicion.
What is the difference between interest (riba) and profit?
Islamic insurance is also as Takaful. What is the meaning of Takaful?
The word Takaful is taken from the Arab word which means mutual help and corporation among the participants managed by the Islamic insurance company.
What is the difference between Takaful and conventional insurance?
Under Takaful, part of the insurance premium paid must be made with the niyyah (intention) of tabarru (donation/charity) and not on the basis of buying and selling (as in conventional insurance). This means that each participant has the niyyah of donating to help another participant who is facing a misfortune and supports the spirit of mutual cooperation.
If the niyyah on the contract is that of buying and selling, elements of Gharar (uncertainties) and gambling similar to the conventional insurance contract will exist. Takaful is not the same as gambling. The aim of Takaful is to lessen the financial burden of participants without the prospect of obtaining a profit from an incident (risk). Gambling however aims at deliberately creating a new risk in the hope of obtaining a profit while facing great possibility of a loss.
Wong Teck Kow
iFast Financial Pte Ltd
|Interest is fixed at the time of contract and is not based on profit or loss.
||Profit distribution is based on profits and fixed at the time of contract.
|Interest rate is based on the amount f money involved.
||The rate of profit financing is based on the amount of profit obtained.
|Payment of interest is fixed as promised without taking into account the profitability of the project managed by the other party.
||Distribution of profit depends totally on the profitability of the project concerned. Should the project be non-profitable or incur losses, the risk is borne by both parties.
|The amount of interest paid does not increase even if the profit obtained is manfold.
||Distribution of profit increases in accordance with the amount of profit obtained.
|Charging and paying interest are prohibited (haram)
||Receiving and distributing profits are permitted (halal).
||Trustee and entrepreneur (Al-Mudarib) under the concept of profit and loss sharing (Mudharabah)
||Owner of fund
||Principles of Takaful
||No direct relation
||Buying and selling
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