In its very basic form, Islamic finance is a way of managing your finances and financial transactions within the principles set out in Sharia law.
The main aim of Islamic finance is to ensure that there are contemporary financial services and products available to those people who want to manage their finances in conformity with Islamic rules and Sharia.
Islamic finance cleverly combined Islamic finance economics with modern lending principles. Interestingly, Islamic finance products are popular with Muslims and non-Muslims.
WHAT IS SHARIA LAW?
The word Sharia has had some bad press in the last few decades. For many non-Muslims, the word Sharia brings up images of beheadings and notions of a rule of law that is alien to them.
However, Sharia law essentially relates to a legal system of rules. The Sharia rules come from the Quran, the holy book for Muslims, the Sunnah, and Hadith (these are the actions and saying of the Prophet Muhammad (SAW).
The literal Arabic meaning of the word Sharia is 'the clear, well-trodden path to water'.
For Muslims, Sharia rules provide a framework of rules for Muslims that guide them when it comes to living their daily lives. Sharia rules apply to things like fasting, donating to charities, and praying. They also apply to other facets of our lives including how we manage our money and financial transactions.
HOW DOES ISLAMIC FINANCE WORK?
The main difference between Islamic finance and conventional finance is that some of the principles that are used within conventional finance are strictly prohibited.
Islamic finance needs to comply with Sharia law, and therefore the following traditional finance practices are prohibited:
- Charging interest or paying any interest
- Investing in prohibited activities and industries such as the porn industry, gambling industries, and industries that make and sell alcohol
- Any form of speculation (masir) or gambling is not allowed
- Risk and uncertainty (gharar) are also forbidden
Any financial transaction that falls within Islamic finance rules will not pay or charge interest.
There are various Islamic finance contracts, services, and products available on the market. Neither will it be uncertain, speculative or risky.
EXAMPLES OF ISLAMIC FINANCE SERVICES
An example of a Sharia compliant savings account is one that does not pay you or charge you interest.
Any money you deposit in your account is seen as interest free loan to the bank - a qard. The bank is permitted to invest the money you have deposited, but they cannot invest in prohibited companies or industries.
When it comes to Islamic finance mortgages, again, no interest is charged or payable. What normally happens is that the bank will buy the property outright and ask you to pay for it in installments.
The incentive for the bank is that they make their profit by selling you the property back at a higher price to cover their fees. This type of mortgage arrangement is considered to be problem solving for those people who do not want a mortgage that comes with interest and increasing debt.
For those looking for any type of insurance, there are many Sharia compliant insurance products on the market, many of them available using a mobile app. What Sharia compliant insurance companies offer their customers is products that are based on pooling money and distributing any surplus.
When it comes to investment, there are Sharia compliant bonds known as sukuk bonds available on the market. These Sharia compliant bonds emerged in the early 2000s. Today, many countries in the world offer sukuk bonds including Malaysia, Saudi Arabia, and Hong Kong.
DIFFERENT TYPES OF ISLAMIC FINANCE ARRANGEMENTS
As mentioned above, many conventional banking systems, practices, and products are not permissible under Islamic finance rules.
This means that new financial products have been created to meet the demand from customers. These products are subject to the same regulation and accounting rules as conventional financial products and services available on the financial market.
Here are some types of financing arrangements that have been specifically developed to comply with Islamic finance principles:
- Mudarabah - this relates to a contract or partnership that is based on profit and loss. Essentially, an investor will provide funds to a partner, and the profits are then shared between them in a pre-agreed ratio.
- Ijarah - this refers to leasing. In this type of Islamic finance arrangement, a lessor will lease the property to a lessee in exchange for rental payments.
- Musharakah - this term refers to joint venture contracts. In these types of investment vehicles the partners to the joint venture will both contribute funds to a project and share the profits and losses.
There are courses available dedicated to learning about Islamic finance, and many banks in the United Kingdom from London through to all the other regions and locations have Islamic finance products available.
ISLAMIC FINANCE - DIFFERENT INVESTMENT VEHICLES
Due to the strict Sharia rules and prohibitions relating to financial products, conventional investment products are not deemed suitable for those wanting to operate within Islamic finance principles.
This has led to the development of investment opportunities to create alternative investment products and services.
One type of alternative investment vehicle includes equities. Sharia rules do not prohibit investment in the shares of companies. As long as the companies and businesses do not operate on or link to industries that are prohibited in Islam then equity investments are permissible.
There are also lots of Sharia compliant bonds and mortgage products available on the market in the United Kingdom and abroad.
Anyone wanting to invest in such companies should always do their own research, check websites and online information or seek those services that have already been vetted for compliance.
Developing these compliant products and services takes time and skill. It is therefore always best to speak to the financial organizations offering Islamic finance services, or those with expert knowledge, so you can understand exactly how they work and operate.
WHY ARE SO MANY NON-MUSLIMS CONVERTING TO ISLAMIC FINANCE?
Islamic finance has been ahead of the game when it comes to ethical finance and investment opportunities. As a set of rules, Islamic finance has been around for centuries for Muslims, but the rules are becoming increasingly popular for non-Muslims.
Non-Muslims, whether as individuals or as a business, are actually a large global consumer of Islamic finance products. This not applies to countries in the Middle East and the Muslim world but also to those beyond.
Non-Muslims are attracted to the ethical foundations of Islamic finance. Investors have also started looking for investments and opportunities that carry less risk. This is important given the state of the global economy in the last few years that has led to people worried about finances, employment and careers. Experts predict that the Islamic finance sector will continue to grow globally.
The global recession following the pandemic has highlighted that many Western financial practices are actually high risk. Therefore, the Islamic finance sector has increased its market share of the conventional banking market.
In Malaysia, when the OCBC launched its Islamic finance subsidiary, great interest was generated from non-Muslim customers.
ISLAMIC FINANCE AND ETHICS
Islamic finance is based on ethical principles. The idea of Islamic finance appeals to Muslims and non-Muslims who want to operate in a more morally appealing way.
Islamic finance is based on Islam's key moral values of enhancing social well-being, justice, and equitability. Investments that adversely affect the economic policy of another community or country as not seen as sustainable for investment customers.
The financial crisis we are currently in, and the one we went through in 2008, have highlighted the importance of having financial systems that are stable and sustainable. Especially following the Covid-19 pandemic which affected capital markets throughout the world including Europe and the United States - previously seen as strong markets.
Following a loss of trust in conventional financial products and sectors, many people are now looking for investments that ethically shape and guide finances and economics.
There is a renewed focus on having financial systems that are inclusive. This in turn should lead to enhanced social wellbeing of those in our communities and countries.
What Islamic finance offers people is the opportunity to ensure their finances are managed in a way that addresses their duty and the consequences of it.
One of the key positives of having an Islamic finance system is that it acknowledges the usefulness of financial management, but elevates it, overarching objectives that place value on ethical and moral conduct.
HOW AVOIDING INTEREST CAN PAY OFF
You might be thinking, how can having a financial system that steers clear of interest generate any profit or interest. The truth is that Islamic finance products and services are on the increase. There is a huge demand for them globally.
The increase in social responsibility, and corporate social responsibility is all about addressing the inequality that results from financial systems that alienate the poor and increase the wealth of the rich.
Despite interest and speculation being forbidden by Islam, Islamic finance products are comparable with conventional finance services when it comes to profits.
Islamic finance focuses on risk management and risk sharing. This means that overall, the risk is lower than it is in conventional financial contracts and services.
The main thing to remember is this - Islamic banks operate in the same way as conventional banks. So how do they make money? Many people who do not understand Islam and Islamic finance have this opinion. The answer is really simple. The way the banks make money (without charging interest) is that they find alternative and Sharia compliant ways to compensate themselves. So, for example, when they offer an interest free mortgage they compensate themselves by having higher repayments.
So whilst banks offering Islamic finance products cannot charge interest they still manage to generate profits. If they didn't then they would not operate in Islamic finance markets.
Instead of lending money to people and businesses so they can buy the product or property, the bank steps in and purchases the car, shop or house.
The risk is shared between the bank and the borrower. This comes back to the principle of ethical lending and investing that underpins Islamic finance.