Islamic finance is sharia compliant way of financing. Sharia, on one hand, prohibits any transaction involving undue uncertainty and on the other hand, it requires avoidance of receiving interest. Sharia defines interest as any income derived in excess of loan. Loans involve personal guarantee of debtor and therefore any such benefit would amount to injustice to debtor. In other words, you can only make profit when you don’t enjoy guaranteed return of the principal amount.
|Islamic finance is Sharia compliant way of raising funds|
Another important aspect of sharia financing is use of money for ethically healthy projects e.g. you cannot invest in projects involving alcohol manufacturing.
Sharia compliant financial institutions have developed many sharia compliant products including modaraba, musharika, sukkuk, murabaha etc. Let’s discuss them one by one
Modaraba is financing mode in which one person provides financial resources and other labour and skills to carry out business. Both share profit, in pre-determined ratio, while losses would accrue to one who invested financial resources.
Musharka is mode of financing in which both partners contribute capital and divide profits/losses according to pre-agreed ratio.
Sukkuk is a bond which gives right of ownership, of some tangible asset, to its holders. The holder of instrument then collects profit as rent of the asset. Three elements of sukkuk as outlined by Taqi Usmani are
· Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues
· Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise
· The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested,
Murabaha is sharia compliant form of leasing. In this form no amount is charged for late payment as it would constitute interest (Riba). Murabaha has become the most prevalent form of Islamic financing.