Islamic Finance in an Islamic economy

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Islamic Finance in an Islamic economy by Mind Map: Islamic Finance in an Islamic economy

1. Money in Islam

1.1. Role of money

1.1.1. a medium of exchange and a standard of measurement (of economic value

1.1.1.1. not an object that can be traded or something that is expected to generate returns without economic activities

2. Framework of Islamic finance

2.1. The principles govern Islamic finance

2.1.1. Principle of equity

2.1.1.1. rationale for the prohibition of predetermined payments (riba),

2.1.1.2. prohibiting excessive uncertainty (gharar)

2.1.1.3. basis of a 2.5 percent levy on cash or in-kind wealth (zakat)

2.1.2. Principle of participation

2.1.2.1. known as interest-free financing but does not imply that capital is not to be rewarded

2.1.2.1.1. reward (profit) comes with risk taking

2.1.2.2. ensure that increases in wealth accrue from productive activities

2.1.3. principle of ownership

2.1.3.1. based on the rules

2.1.3.1.1. do not sell what you do not own

2.1.3.1.2. you cannot be dispossessed of a property except on the basis of right

3. Instruments in Islamic finance

3.1. Profit-loss-sharing

3.1.1. musyarakah

3.1.1.1. a contract of joint partnership

3.1.1.1.1. where two or more partners provide capital

3.1.1.1.2. to finance a project or own real estate or movable assets

3.1.1.1.3. either on a permanent or diminishing basis

3.1.1.2. most authentic form of Islamic financing

3.1.1.3. partners have right to take part in management

3.1.1.4. profits are distributed according to pre-agreed ratios

3.1.1.5. losses are shared in proportion to capital contribution

3.1.2. mudarabah

3.1.2.1. profit-sharing and loss-bearing contract

3.1.2.1.1. where one party supplies funding (rabbul mal)

3.1.2.1.2. another party provides effort and management expertise to generate profit (mudarib)

3.1.2.2. sometimes referred as a sleeping partnership

3.1.2.2.1. because mudarib runs the business and the rabbul mal cannot interfere in management

3.1.2.3. islamic bank uses mudarabah to raise funds and for the management of mutual funds

3.2. Non-profit loss sharing

3.2.1. murabahah

3.2.1.1. used in trade and asset financing

3.2.1.2. bank purchases the goods and delivers them to the customers

3.2.1.3. expected return on usually aligned with interest payments on conventional loans

3.2.1.4. is a deferred payment sale transaction

3.2.1.4.1. where the intention is to facilitate the acquisition of goods

3.2.1.4.2. not to exchange money for more money

3.2.1.5. penalty cannot be imposed, unless

3.2.1.5.1. buyer has deliberately refused to make a payment (ta'widh)

3.2.2. ijarah

3.2.2.1. contract of sale of the right to use an asset for a period of time

3.2.2.2. a lease contract

3.2.2.2.1. leasor must own the leased asset for the entire lease period

3.2.2.2.2. leasor responsible for asset maintenance

3.2.2.3. to make ijarah payment permissible, need to have element of risk

3.2.2.4. if there is a promise

3.2.2.4.1. leasor can sell the asset to the lessee at the end of the lease agreement

3.2.2.4.2. with price of the residual asset being predetermined

3.2.2.5. lessee have option to

3.2.2.5.1. buy the leased asset at the conclusion of the contract or simply return it to the owner

3.2.2.5.2. or simply return it to the owner

3.2.3. salam

3.2.3.1. forward agreement where delivery occurs at a future date in exchange for spot payment

3.2.3.2. originally allowed to meet the financing needs of small farmers

3.2.3.2.1. because they were unable to yield adequate returns until several periods after the initial investment

3.2.3.3. condition for the validity

3.2.3.3.1. payment of the price in full at the time of initiating the contract

3.2.3.4. should be specified in contract

3.2.3.4.1. subject matter

3.2.3.4.2. price

3.2.3.4.3. quantity

3.2.3.4.4. date and place to deliver

3.2.3.5. in event that the seller can neither produce the goods nor obtain them elsewhere

3.2.3.5.1. buyer can either take back the paid prices with no increase

3.2.3.5.2. or wait until the goods become available

3.2.4. istisna'

3.2.4.1. contract in which a commodity can be transacted before it comes into existence

3.2.4.2. bank agrees to receive payments from the client on a longer-term schedule

3.2.4.3. whereas under the second contract, the bank (as a buyer) makes progress installment payments to the producer over a shorter period of time

3.3. Fee-based products

3.3.1. 3types of contract

3.3.1.1. wakalah

3.3.1.1.1. results from the bank acting as the agent of a customer in a trade transaction or issuing a letter of credit facility

3.3.1.2. kafalah

3.3.1.2.1. financial guarantee whereby the bank gives a pledge to a creditor on behalf of the debtor to cover fines or any other personal liability

3.3.1.3. ju'ala

3.3.1.3.1. essentially an istisna’ contract that is applicable for rendering a specified service as opposed to the manufacturing of a product

3.3.2. usually auxiliary to the main murabaḥah and mudarabah transactions

3.3.3. fee-based services provided by Islamic banks include :

3.3.3.1. bank transfers

3.3.3.2. issuing letters of credit and guarantees

3.3.3.3. credit cards

3.3.3.4. offering collection and safe-custody services

4. Islamic finance and banking

4.1. Sukuk

4.1.1. an Islamic bonds

4.1.1.1. to generate returns to investors without infringing Islamic law

4.1.2. represents undivided shares in the ownership of tangible assets relating to particular projects or special investment activity

4.2. Insurance vs takaful

4.2.1. insurance contract can be defined as

4.2.1.1. an agreement whereby an insurer undertakes (in return for the agreed premium) to pay a policyholder a sum of money (or its equivalent) on the occurrence of a specified event

4.2.1.2. have some element of uncertainty

4.2.1.2.1. timing of its occurrence is uncertain

4.2.1.2.2. occurrence of the event depends upon accidental causes

4.2.1.2.3. and may never happen at all

4.2.1.3. 5 elements involve

4.2.1.3.1. Two parties ; insured and insurer

4.2.1.3.2. An agreed premium

4.2.1.3.3. An amount to be paid to cover a specified losser losses

4.2.1.3.4. The specified loss or losses should have a remote chance of occurring

4.2.1.3.5. The policy holder who is taking out the insurance should have an interest in what is being insured

4.2.2. first fatwa that explicitly prohibited commercial insurance was made by Ibn Abdeen

4.2.3. life insurance involves the use of certain elements that directly contradict the rules of Shari’a

4.2.3.1. maisir

4.2.3.1.1. policyholder loses the premium paid if does not claim or the loss does not occur

4.2.3.1.2. policyholder may be entitled to receive a bigger amount than what he/she deserves compared to the premium

4.2.3.2. gharar

4.2.3.2.1. nobody knows when the loss will occur or what will be the amount, or whether it will occur or not

4.2.4. takaful

4.2.4.1. policyholders are deemed to donate a sum of money to help each other in case anyone of them suffers loss