ISLAMIC FINANCE IN ISLAMIC ECONOMIC

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ISLAMIC FINANCE IN ISLAMIC ECONOMIC by Mind Map: ISLAMIC FINANCE IN ISLAMIC ECONOMIC

1. Money in Islam

1.1. Definition: Medium of exchange and a standard of management

1.1.1. Money is an object that can be traded or something that is expected to generate returns without economic activities

2. Instrument in Islamic Finance

2.1. Profit and Loss Sharing

2.1.1. Musharakah

2.1.1.1. Joint partnership

2.1.1.1.1. where two or more partners provide capital

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

2.1.1.1.3. either on a permanent or diminishing basis.

2.1.1.2. most authentic form of Islamic financing

2.1.1.3. Partners have a right to take part in management

2.1.1.4. bear the greatest risk among all Islamic financing modes with the potential for earning the highest reward

2.1.1.5. profits are distributed according to pre-agreed ratiosc

2.1.2. Mudarabah

2.1.2.1. profit-sharing and loss-bearing contract

2.1.2.1.1. where one party supplies funding(rabbul mal)

2.1.2.1.2. the other provides effort and management expertise(mudarib) with a view to generating a profit

2.1.2.2. sleeping partnership

2.1.2.2.1. the mudarib runs the business and the financier cannot interfere in management

2.1.2.3. IB uses mudarabah financing to raise funds

2.1.2.4. mudarabah contracts are also used for the management of mutual funds.

2.2. Non Profit and Loss Sharing

2.2.1. Murabahah

2.2.1.1. popular Shari’ah-compliant sale transaction

2.2.1.2. mostly used in trade and asset financing

2.2.1.3. The bank purchases the goods and delivers them to the customer, deferring payment to a date agreed by the two parties.

2.2.1.4. expected return on murâbaḥah is usually aligned with interest payments on conventional loans

2.2.1.4.1. creating a similarity between murâbaḥah sales and asset-backed loans.

2.2.1.5. deferred payment sale transaction

2.2.1.5.1. intention is to facilitate the acquisition of goods

2.2.1.5.2. and not to exchange money for more money over a period of time.

2.2.1.5.3. a penalty cannot be imposed

2.2.2. Ijarah

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

2.2.2.2. a lease contract

2.2.2.2.1. whereby the leaser must own the leased asset for the entire lease period

2.2.2.2.2. ownership remains with the leaser, the asset can be repossessed in case of nonpayment by the lessee

2.2.2.3. element of risk is required for making ijārah payments permissible

2.2.2.4. if there is a promise

2.2.2.4.1. the leaser can sell the asset to the lessee at the end of the lease agreement

2.2.2.4.2. with the price of the residual asset being predetermined

2.2.2.4.3. or simply return it to the owner

2.2.2.5. option

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

2.2.3. Salam

2.2.3.1. a form of forward agreement where delivery occurs at a future date in exchange for spot payment

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

2.2.3.2.1. as they were unable to yield adequate returns until several periods after the initial investment

2.2.3.3. vital condition for the validity

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

2.2.3.3.2. or else the outcome is a debt-against-debt sale, which is strictly prohibited under Shari’ah

2.2.3.4. should be precisely specified in the contract

2.2.3.4.1. subject matter

2.2.3.4.2. price

2.2.3.4.3. quantity

2.2.3.4.4. date

2.2.3.4.5. place of delivery

2.2.3.5. seller can neither produce the goods nor obtain them elsewhere

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

2.2.3.5.2. or wait until the goods become available

2.2.3.6. one of the parties fail to fulfill their contract

2.2.3.6.1. the bank will get back its initial investment, but will have to accept the lost profit

2.2.3.7. To reduce exposure to credit risk,

2.2.3.7.1. the bank may ask for a financial guarantee, mortgage, advance payment, or third-party guarantee

2.2.4. Istisna

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

2.2.4.2. nothing is exchanged on the spot or at the time of contracting

2.2.4.3. first istisna’ contract

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

2.2.4.4. second istisna' contract

2.2.4.4.1. the bank (as a buyer) makes progress installment payments to the producer over a shorter period of time

2.3. Fee-based product

2.3.1. 3 types of contract

2.3.1.1. wakalah

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

2.3.1.2. kafalah

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

2.3.1.3. ju'ala

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

2.3.2. usually auxiliary to the main murâbaḥah and mudârabah transactions

2.3.2.1. though they generate various types of fees and commissions

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

2.3.3.1. bank transfers

2.3.3.2. issuing letters of credit and guarantees

2.3.3.3. credit cards

2.3.3.4. offering collection and safe-custody services

3. Islamic Finance

3.1. Sukuk

3.1.1. Islamic bonds

3.1.1.1. to generate returns to investors without infringing Islamic law

3.1.2. Definition: 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

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

3.2. Insurance vs Takaful

3.2.1. Commercial Insurance

3.2.1.1. Uncertainty element

3.2.1.1.1. the timing of its occurrence

3.2.1.1.2. or the fact that the occurrence of the event depends upon accidental causes, and the event, therefore, may never happen at all.

3.2.1.2. 5 elements involved

3.2.1.2.1. Two parties−the insured and the insurer

3.2.1.2.2. An agreed premium

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

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

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

3.2.2. The first fatwa that explicitly prohibited commercial insurance in its modern application and its related activities was made by Ibn Abdeen in 1834

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

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

3.2.4.1. Maisir

3.2.4.1.1. policyholder loses the premium paid if he/she does not claim or the loss does not occur

3.2.4.2. Gharar

3.2.4.2.1. neither the insured nor the insurer knows when the loss will occur or what will be the amount, or whether it will occur in first place

3.2.5. Takaful

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

4. Framework of Islamic Finance

4.1. Principles Govern Islamic FInance

4.1.1. Principles of Equity

4.1.1.1. Prohibition of riba

4.1.1.2. Prohibition of gharar

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

4.1.2. Principles of Participation

4.1.2.1. Commonly known as interest-free financing

4.1.2.2. ensuring that increases in wealth accrue from productive activities

4.1.2.2.1. According to a key Shari’ah ruling that “reward (that is, profit) comes with risk taking"

4.1.3. Principles of Ownership

4.1.3.1. “do not sell what you do not own” (for example, short-selling)

4.1.3.2. “you cannot be dispossessed of a property except on the basis of right”