Islamic Financial System

Basic Islamic Financial System Concepts

By Muhammad Amir

Islamic Banking-The Basic Concepts of Islamic banking, also referred to as Islamic finance or Shariah-compliant finance, refers to financial activities that adhere to Shariah (Islamic law). Two fundamental principles of Islamic banking are?the?sharing of profit and loss?and the prohibition of the collection and payment of interest by lenders and investors.

What is concept of Islamic finance? Islamic finance is?a way to manage money that keeps within the moral principles of Islam. It covers things like saving, investing, and borrowing to buy a home. The moral principles many Muslims live their lives by are sometimes known as the 'Shari'ah'.

?What are four 4 components of Islamic financial system?

The Islamic financial system encompasses the?Islamic banking system, Islamic money market, Islamic insurance or takaful, Islamic capital market?and the specialized financial institutions which provide alternative sources of financing.

What are the principles of Islamic financial system?

The main principles of Islamic finance are that:?Wealth must be generated from legitimate trade and asset-based investment. (The use of money for the purposes of making money is expressly forbidden.) Investment should also have a social and an ethical benefit to wider society beyond pure return.

What is Islamic accounting concept?

1 Islamic accounting is?an alternative accounting system which aims to.?provide users with information enabling them to operate businesses and.?organizations according to Shariah, or Islamic law.

The practices of Islamic banking are?usually traced back to business people in the Middle East who started engaging in financial transactions with their European counterparts during the Medieval era. At first, they used the same financial principles as the Europeans.

One of the primary differences between conventional banking systems and Islamic banking is that Islamic banking prohibits?usury ?and?speculation . Shariah strictly prohibits any form of speculation or gambling, which is referred to as?maisir. Shariah also prohibits taking interest on loans. In addition, any investments involving items or substances that are prohibited in the Quran—including alcohol, gambling, and pork—are also prohibited. In this way, Islamic banking can be considered a culturally distinct form of ethical investing

To earn money without the typical practice of charging interest,?Islamic banks use?equity participation ?systems. Equity participation means if a bank loans money to a business, the business will pay back the loan without interest and instead give the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit. In general, Islamic banking institutions tend to be more risk-averse in their investment practices. As a result, they typically avoid business that could be associated with economic bubbles.

Beginning in the 1960s, Islamic banking resurfaced in the modern world, and since 1975, many new interest-free banks have opened. Though the majority of these institutions were founded in Muslim countries, Islamic banks also opened in Western Europe during the early 1980s.?In addition, national interest-free banking systems have

been developed by the governments of Iran, Sudan, and (to a lesser extent) Pakistan.

Example of Islamic Banking

The Mit-Ghamr Savings Bank, established in 1963 in Egypt, is commonly referred to as the first example of Islamic banking in the modern world. When Mit-Ghamr loaned money to businesses, it did so based on a?profit-sharing ?model. The Mit-Ghamr project was closed in 1967 due to political factors, but during its year of operations, the bank exercised a great deal of caution, only approving about 40% of its business loan applications. However, in economically good times, the bank's default ratio was said to be zero.

How Are Conventional and Islamic Banking Different?One of the primary differences between conventional banking systems and Islamic banking is that Islamic banking prohibits usury and speculation. Shariah strictly prohibits any form of speculation or gambling, which is referred to as?maisir. Shariah also prohibits taking interest on loans. Also, any investments involving items or substances that are forbidden in the Quran—including alcohol, gambling, and pork—are also prohibited. In this way, Islamic banking can be considered a culturally distinct form of?ethical investing .

How Do Islamic Banks Make Money?

To earn money without the typical practice of charging interest, Islamic banks use equity participation systems, which is similar to profit sharing. Equity participation means if a bank loans money to a business, the business will pay back the loan without interest and instead give the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit.?????????

What are four 4 components of Islamic financial system?

The Islamic financial system encompasses the?Islamic banking system, Islamic money market, Islamic insurance or takaful, Islamic capital market?and the specialized financial institutions which provide alternative sources of financing.

What is Islamic finance system?

Islamic banking is?an interest free banking system?and is governed by the principles laid down by Islamic Sharia'h. Commonly Islamic modes used for saving deposits is Mudharaba and Qarz for current deposits while Murabaha, Ijarah, Diminishing Musharakah and other modes used for financing.

What are modes of financing?

Project finance?is a mode of financing designed for long-term capital-intensive projects whereby the source of financing repayment is solely based on the cash flow generated from the project.

How many types of financial contracts are there in Islam?

two types

Essentially, there are?two?types of Islamic financial contracts, namely commutative and non-commutative.

?How Many Types of Islamic Financing Mod?

·????????Murabaha.

·????????Ijarah.

·????????Istisnaa.

·????????Mudarabah.

·????????Musharaka.

·????????Tawarooq.

·????????That are the principles of Islamic finance?

·????????The main principles of Islamic finance are that:?Wealth must be generated from legitimate trade and asset-based investment. (The use of money for the purposes of making money is expressly forbidden.) Investment should also have a social and an ethical benefit to wider society beyond pure return.

?What is the importance of Islamic finance?

Islamic finance?provides financial services for all segments of the population and can help increase financial inclusion. Islamic finance also serves as an alternative source for funding infrastructure and as a means of diversifying funding and risk exposures of investors.

An Islamic personal loan is?where the bank buys an asset on behalf of the borrower and selling it at a profit?- this profit rate replaces the interest rate (used by conventional loans) as Islamic loans are prohibited from charging interest (Riba).

How does Islamic finance make money?

The interest rates are promoted and marketed as a way to get customers to invest and keep their money with the bank. However, in Islamic finance,?savings accounts are typically advertised or market according to some record or profit/loss.

What is meant by Murabaha?

Murabaha is?an Islamic financing structure that works as a sales contract, fixing the price of goods or items as required by a customer, inclusive of a pre-agreed profit margin.

?What are the modes of deposit and investment of Islamic banking?

It combines three modes:?rent (Ijara), partnership (Shirkat) and buying and selling. a) The Bank and the client invest their capital jointly through a contract called partnership (Shirkat).

?What is Ijarah and murabaha?

The main difference between these two types is that with a Murabaha mortgage the property will immediately be registered in your name, while with an Ijara mortgage, you can only rent the property from your sharia-compliant lender, where you'd have to pay a monthly rent and at the end of the agreed term.

?What are different types of Islamic contracts?

The Essentials are given below:

Murabaha (Agreed profit margin sale with cash or deferred payment of price)

?Musawamah. ...

?]Ijarah (Leasing)

·Salam (Advance payment--Deferred Delivery Sale)

Musharaka.

Mudaraba.

?Istisna.

What is tawarruq financing?

Tawarruq is?a financing arrangement where customer will be receiving cash at the end of it for his needs through a series of sale transactions. How Tawarruq is done? The bank will purchase commodities from a supplier (first sale) and sells them to customer (second sale).

?There are two types of Mudarabah:?restrictive and unrestrictive. Restrictive Mudarabah means that the investor has specified investment details in the Mudarabah contract and has restricted the working partner within the scope of such specifications.

Each of the key beliefs explored; Tawhid (Unity), Ihtiram (Respect), Ikhlas (Sincerity), Iqtisad (Moderation/ Humility), Haya' (Modesty), 'Ilm (Pursuit of Knowledge), Dhikr (Remembrance), will contextualise and shed light on the visible and invisible nature of both the Islamic belief discussed and its corresponding ...

The Bank can use these funds for investment and other purposes regardless Shariah prohibition.

...Lending / Financing

Conventional

Islamic

Conventional banks are in the business of lending & borrowing money based on interest.

Islamic Banks are not money lending institutes but they work as a trading/ investment house.

Features of Islamic Banking

A. Certainty of capital and return. While the conventional banks guarantee the capital and rate of return, the Islamic banking system, working on the principle of profit and loss sharing cannot guarantee any fixed rate of return on deposits. ...

B. Supervision and control. ...

C. Tax regulations.

The general conclusion is that?Islamic banks are less efficient, have higher intermediation ratios and higher asset quality, and are better capitalized. The latter two indicators in particular have helped Islamic banks outperform during the financial crisis. The foundation of the Islamic Banking model is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. This system of financial intermediation?contributes to a more equitable distribution of income and wealth.

What is the difference between Islamic loan and conventional loan?In conventional loans, a bank lends you money and in return, you repay the loan with interest. Islamic financings are trade transactions where the profit is fixed right from the start which the customer has contracted from the beginning to pay.

What is a halal loan?

Halal loans are?loans provided by banks that operate according to the Islamic rules of Shariah. These rules, called as Fiqh al-Muamalat, are based the Islamic rules of transactions and promote principles of Islamic economics.

What is the difference between conventional and Islamic personal loan?

An Islamic loan is based on Shariah Laws, the Islamic religious law as stated in the Quran, Hadith and Sunnah. Unlike conventional loans where money is seen as a commodity, there is no money loaned to the borrower as the bank will “purchase” the item for the borrower and sell it to them at a higher price.

Are Islamic banks really interest free?

What is crystal clear is that?what passes as Islamic finance is anything but interest-free. Almost all of the Islamic banks in existence, including those in Egypt, charge their borrowers what any economist would call interest; they also pay their depositors interest as a matter of course.

?What are the disadvantages of Islamic banking?

Another disadvantage of Islamic banks is that?they don't provide business loan for all kinds of businesses. They prohibit funding of unethical ventures such as, alcohol, tobacco, ammunition manufacturing and adult entertainment institutions and also prohibits any form of gambling

Is Islamic finance more expensive?

“Overall,?Islamic mortgages are a little more expensive than conventional mortgages?just because of the transaction costs and the way it's set up,” said Dr. Mohammad Kabir Hassan, a finance professor at the University of New Orleans and expert on Islamic finance.

What is Mudarabah and musharakah?

Mudarabah (??????) refers to "trustee finance" or passive partnership contract, while Musharakah (?????? or ?????) refers to equity participation contract. Other sources include sukuk (also called "Islamic bonds") and direct equity investment (such as purchase of common shares of stock) as types of PLS.

What is the meaning of Mudarabah?

The term 'Mudaraba' has been derived from one of the meanings of the Arabic word '???' which means 'Travel'. Thus the word 'Mudaraba' means?'Travel' for undertaking business. Mudaraba is a partnership in profit whereby one party provides capital and the other party provides skill and labour.

?Is murabaha Halal or Haram?

In case of Murabaha,?the bank sells an asset and charges profit which is a trade activity declared halal (valid) in the Islamic Shariah. Whereas giving loan and charging interest thereupon is pure interest-based transaction declared haram (prohibited) by Islamic Shariah.

?What is the popular Islamic mode of investment for term loan?

Murabaha?is the most frequently used form of finance in Islamic banking throughout the world.

What are the sources of Islamic funds?

Similar to conventional banks, Islamic banks also need funds to operate its banking activities. Basically there are two (2) main sources of funds, namely (a)?Shareholders' working capital and (b) Deposits collected from Customers.

?What are the Islamic financial instruments?

Financing instruments in Islamic finance consist of equity-like and debt-like instruments. Fixed claim instruments include?murabaha, ijarah, salam, and istisna. Sukuk is an asset-backed trust certificate (bond) representing ownership of an asset or its usufruct (earnings) based on the principle of sharia.

What is Sukuk murabaha?

In a sukuk al-murabaha transaction:?A special purpose vehicle (SPV) buys from a supplier an asset the borrower has identified. The SPV finances the purchase of these assets with the proceeds of a sukuk issuance. The SPV sells the asset to the borrower for the original purchase price plus a pre-agreed profit.

?What is Mudarabah with examples?

Mudarabah means?any amounts given by or to the financial institution for the purpose of doing business on the basis of sharing of the profits and losses; Sample 1. Mudarabah means a form of partnership where one partner provides funds, while other provides expertise and management.

What is the meaning of Sukuk?

A sukuk is?an Islamic financial certificate, similar to a bond in Western finance, that complies with Islamic religious law commonly known as Sharia.

?Elements of Contract in Islamic Law:

Majority is of the view that the essential elements of a contract are four: (a) Sighah the form i.e. (offer and acceptance); (b) the seller; (c) the buyer and (d) the subject matter (ma`qud `alayh).

What are the basic elements of Islamic contract?

There are six elements which need to be fulfilled:?(i) the offeror and the offeree; (ii) offer and acceptance; and (iii) the subject matter and consideration. To be legally competent to enter into a contract the parties have to have prudence of sound judgement and be at the age of puberty.

?What are the types of contract?

On the basis of validity or enforceability, we have five different types of contracts as given below.

·????????Valid Contracts. ...

·????????Void Contract or Agreement. ...

·????????Voidable Contract. ...

·????????Illegal Contract. ...

·????????Unenforceable Contracts.

What is commodity Murabaha financing?

The Commodity Murabaha is a financing transaction based on purchase and sale, whereby the Bank purchases a commodity from a broker and sells it to the Customer through the Murabaha agreement with a set markup either in the form of a lump sum or percentage.

?What is Ijarah contract?

Ijarah is a concept used in Islamic commerce. Ijarah denotes?a contract where one party transfers the right to use an item he owns to another party for a specified period in exchange for an agreed consideration. Colloquially, Ijarah is often called 'Islamic leasing'.

?Is Tawarruq Haram?

However, it is the third form that raises opposing views from the jurists. There are three different views regarding tawarruq from the jurists, and they classify tawarruq as permissible (harus/ halal), reprehensible (makruh) and?prohibited (haram).

What is musharakah contract?

Musharakah is?a joint partnership arrangement in Islamic finance in which profits and losses are shared. Profits from interest are not permitted in Islamic practice, necessitating the need for musharakah.

What is Modaraba example?

Modaraba or Mudarabah is?a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise.

What is two tier Mudarabah?

two-tier mudaraba. Definition English:?A pre-Islamic, Arabic type of finance in which one individual provides start-up capital to another individual who will do the actual work.

?What can Muslims not do?

This meat is called “halal.” Muslims are also prohibited from gambling, taking interest, fortune-telling, killing, lying, stealing, cheating, oppressing or abusing others, being greedy or stingy, engaging in sex outside of marriage, disrespecting parents, and mistreating relatives, orphans or neighbors.

What are four 4 components of Islamic financial system?

The Islamic financial system encompasses the?Islamic banking system, Islamic money market, Islamic insurance or takaful, Islamic capital market?and the specialized financial institutions which provide alternative sources of financing.

What are the principles of Islamic finance?

The main principles of Islamic finance are that:?Wealth must be generated from legitimate trade and asset-based investment. (The use of money for the purposes of making money is expressly forbidden.) Investment should also have a social and an ethical benefit to wider society beyond pure return.

?How do Islamic loans work?

Islamic financing is instead based on making a profit through the sale of commodities. Basically, the buyer asks the bank to buy the exact item that they want financed, which is then sold to them at an additional markup. The buyer is then asked to pay for the item in instalments or through a “rent-to-own” scheme

?What is the objective of Islamic finance?

At the macro level, the goal is?to realise social justice. The Islamic financial system attempts to realise economic justice through wealth circulation, efficiency in resource utilisation, fulfilling society's basic needs, elimination of poverty and improving human wellbeing.

?What is Islamic personal financing?

An Islamic personal loan is?where the bank buys an asset on behalf of the borrower and selling it at a profit?- this profit rate replaces the interest rate (used by conventional loans) as Islamic loans are prohibited from charging interest (Riba).

What are the advantages of Islamic finance?

The sustainable development of Islamic finance offers benefits for?economic growth, reducing poverty and fostering shared prosperity. Islamic finance can significantly contribute to economic development, given its direct link to physical assets and the real economy.

What are the disadvantages of Islamic economic system?

Islamic finance institutions have extra compliance increasing issue / transaction costs. Banks need to know more than usual so more due diligence work is required. Some Islamic products may not be compatible with international financial regulation

?What is the future of Islamic finance?

Despite the challenging conditions, rating agency Standard & Poor's has projected that the Islamic finance industry will still show?low to mid-single-digit growth in 2020-2021?after the 11.4% growth in 2019 led by strong performance in the Sukuk market.

?How do Islamic banks make profit?

Islamic financial institutions also generate profits?through Murabaha. Under Murabaha, an Islamic bank purchases an asset on behalf of a client, e.g. a car, and resells that asset to the client at a marked-up price. Usually, the client pays for the asset in instalments.

?How is Islamic finance different?

There are many differences between Islamic and mainstream finance, but two of the most important are?the sharing of profit and loss, and the prohibition of the collection and payment of interest by lenders and investors. Shariah also prohibits taking interest on loans.

?Why is Islamic mortgage more expensive?

Are Islamic mortgages more expensive? Islamic mortgage products can be more expensive than other mortgages because?the Sharia-compliant lender has to cover higher administration costs. It's also likely you'll need to put down a larger deposit.

?Why is Islamic finance better than conventional?

The general conclusion is that?Islamic banks are less efficient, have higher intermediation ratios and higher asset quality, and are better capitalized. The latter two indicators in particular have helped Islamic banks outperform during the financial crisis.

?What is difference between Islamic and conventional account?

In Islamic banking leasing, ownership remains with bank and risk and reward bear by the bank as owner of asset.?In conventional banking, fixed rate of interest being given to depositors. In Islamic banking, profit are distributed out of profit earning by bank for the month as per decided weightages.

?What is the difference between Islamic bank and commercial bank?

Commercial banking is based on manmade rules and focus on interest financing.?Islamic banks perform functions as commercial banks but they follow the rules of Islamic Sariah board. Islamic banking is the interest free banking. They follow the Islamic modes of finance Mudarabah, Musharaka, Ijarah?

?Are mortgages allowed in Islam?

As mortgages by their very nature are interest-bearing,?they're prohibited in the Muslim faith.

?Are interest free loans halal?

As a matter of faith, a Muslim cannot lend money to, or receive money from someone and expect to benefit –?interest (known as riba) is not allowed.

?Is Islamic loan better than conventional?

Any loan given by Islamic Banks must be interest free.?Conventional Bank treats money as a commodity and lend it against interest as its compensation. Islamic banking products are usually asset backed and involves trading of assets, renting of asset and participation on profit & loss basis.

?

?

Are Islamic loans cheaper?

– Due to the non-compounding nature,?the total profit payable for the financing will be much lower as compared with conventional loans. This also means that late home loan payments might incur cheaper charges.

?Why do people prefer Islamic banking?

Also in the study almost every respondent agreed that they prefer Islamic banking because of?religious views. They also consider this system moral and more ethical than conventional banking. Many participants said that Islamic banking encourage the equal distribution of wealth between the individual and society.

Why Islamic banking is the best?

The foundation of the Islamic Banking model is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. This system of financial intermediation?contributes to a more equitable distribution of income and wealth.

?What is Murabaha and Mudaraba?

equity-based profit and loss sharing methods within Islam?known as mudaraba (trust financing), musharaka (participating finance), murabaha (cost plus trade financing) and sukuk (Islamic. bonds).

?What are the types of musharakah?

Shirkat-ul-'aqd is further divided into three kinds:

. Shirkat-ul-amwal (contractual partnership)

·????????Shirkat-ul-A'mal (liability partnership)

·????????Shirkat-ul-wujooh (vocational partnership)

?

What is the difference between riba and murabaha?

There are also Islamic investment funds and sukuk (Islamic bonds) that use murabahah contracts.?The purpose of murabaha is to finance a purchase without involving interest payments, which most Muslims (particularly most scholars) consider riba (usury) and thus haram (forbidden).

?What kind of murabaha a loan?

In Islamic finance,?murabaha financing is used in place of loans. Murabaha is also referred to as cost-plus financing because it includes a profit markup in the transaction rather than interest. A seller and buyer agree to the cost and the markup, which are then paid in installments.

?Is Mudarabah prohibited in Islam?

On this basis?Mudarabah is completely against the teaching of Quran. The reason is that in such type of partnership the financer (Rab-ul-mal) takes the rewards of his capital which is strictly prohibited by Quran in Chapter 2 verses 275-179. Hence, this method is against the basic teaching of Quran.

?What are financing modes?

Project Finance. Project finance is a mode of financing designed for long-term capital-intensive projects whereby the source of financing repayment is solely based on the cash flow generated from the project.

What is the difference between riba and interest?

Key Takeaways. In Islamic finance,?riba refers to interest charged on loans or deposits. Religious practice forbids riba, even at low interest rates, as both illegal and unethical or usurious. Islamic banking has provided several workarounds to accommodate financial transactions with charging explicit interest.

?What are the sources of Islamic funds?

Similar to conventional banks, Islamic banks also need funds to operate its banking activities. Basically there are two (2) main sources of funds, namely (a)?Shareholders' working capital and (b) Deposits collected from Customers.

?What are the modes of deposit and investment of Islamic banking?

It combines three modes:?rent (Ijara), partnership (Shirkat) and buying and selling. a) The Bank and the client invest their capital jointly through a contract called partnership (Shirkat).

?What are four 4 components of Islamic financial system?

The Islamic financial system encompasses the?Islamic banking system, Islamic money market, Islamic insurance or takaful, Islamic capital market?and the specialised financial institutions which provide alternative sources of financing.

?What is the difference between bond and sukuk?

Sukuk are Sharia-compliant financial certificates through which investors gain partial ownership on an issuer's assets until the Sukuk maturity date. While Bonds are financial certificates through which investors lend money to the issuer, indicating an obligation for repayment at maturity date.

?What is Ijarah sukuk?

Ijarah Sukuk are certificates of equal value which are issued by the owner of an existing property or asset either on his own or through a financial intermediary, for the purpose of leasing it against a rental from the subscription proceeds.

?What are types of sukuk?

Sukuk can be divided into four several types based on the structure namely:?asset-based Sukuk , asset-backed Sukuk , exchangeable Sukuk and hybrid Sukuk?. Most of the outstanding Sukuk issuances are asset-based

?What is meant by musharakah?

Under Islamic law, Musharaka refers to a joint partnership where two or more persons combine either their capital or labor, forming a business in which all partners share the profit according to a specific ratio, while the loss is shared according to the ratio of the contribution?

?How many types of Mudarabah are there?

two types

There are?two?types of Mudarabah transaction: 1) Mudarabah Mutlaqah and 2) Mudarabah Muqayyadah

?Why is Mudarabah important?

Mudarabah is a type of partnership where?one party provides capital and the other party provides labor and management skills.

?What is the meaning of Islamic finance?

Islamic finance is?a way to manage money that keeps within the moral principles of Islam?. It covers things like saving, investing, and borrowing to buy a home. The moral principles many Muslims live their lives by are sometimes known as the 'Shari'ah'.

?What are different types of Islamic contracts?

The Essentials are given below:

·????????Murabaha (Agreed profit margin sale with cash or deferred payment of price)

·????????Musawamah. ...

·????????Ijarah (Leasing)

·????????Salam (Advance payment--Deferred Delivery Sale)

·????????Musharaka.

·????????Mudaraba.

·????????Istisna.

?How is murabaha profit calculated?

Profit= [Amount Financed (F) * Profit Rate(R) * Term of financing]?Profit= [1,000,000*5%*60/12] = 250,000. In case of an early payment, the customer may get a rebate

?What are the 5 basic types of contracts?

Other contract types include?incentive contracts, time-and-materials, labor-hour contracts, indefinite-delivery contracts, and letter contracts.

?What are 3 types of contracts?

The three most common contract types include:

·????????Fixed-price contracts.

·????????Cost-plus contracts.

·????????Time and materials contracts.

What is murabaha in Islamic?

Murabaha is?an Islamic financing structure that works as a sales contract, fixing the price of goods or items as required by a customer, inclusive of a pre-agreed profit margin.

?What is the difference between sale and murabaha?

The key difference lies in the contract structure.?Murabaha is a sale contract, while the conventional loan is an interest based lending agreement and transaction. Under a Murabaha agreement, the bank sells a commodity for profit where both the original cost and the profit are disclosed to the buyer.

Is Ijara Loans halal?

Whether you are looking for an Islamic loan for your home or business, we have a competitive solution that will meet your needs. We offer Murabaha, Musharaka or Ijara wa Iqtina Islamic mortgage alternatives which are?Shariah compliant. If you are looking for a Halal mortgage that is Riba Free, we can help.

What is wakalah contract?

Summary. Wakalah literally means protection, delegation, or authorization. Legally, wakalah refers to?a contract in which a person who has complete legal capacity authorizes another to conclude a certain well-defined permissible contract on behalf of that person