Download Special Topics in Finance: Chapter 1,2,3,and 4 Summary FINA4351

Special Topics in Finance: Chapter 1,2,3,and 4 Summary
FINA4351
Name: Rahma Alkhuder
ID: 200800624
Chapter 1: Overview of Contemporary Islamic Finance
Contemporary Islamic laws have various principles that administrate how they
account for their finance. One is abiding by the Islamic laws, also called sharia and the
second principle is prohibition of giving and receiving of interest, also called riba. Third
is avoiding any risk, speculation and uncertainty, also called gharar. For instance, sharia
law prohibits practices like gambling and their funding. In Islamic finance, gharar
involves essential events of uncertainty in a contract such as price, while riba entails the
interest charged in lent money.
In Islamic financing, both rewards and risks are shared between the two parties
in a contract. However, the degree of each person’s share varies from one contract to
another. An example of a financing that involves high degree of risk and reward is
venture capital, while sale of assets on credit or installment is a low degree risk and
reward financing.
The reason why contemporary Islamic finance incorporates Islamic financing in
its product is to comply with sharia law in investing and financing. Banking emerged
because of growth in businesses. First banks came from ancient temples around the
Mediterranean Sea. The business transactions were between moneylenders and
priests. In these transactions, deposit formed the basis of the first currency. These
banks accompanied with various types of products such as loans, credit facility and
many others. The availability of cross-cultural coinage opened ways for international
business, which allowed global exchange of currency.
Current Islamic banking movement began in 1963 with the setting up of Mit
Ghamr Islamic bank in Egypt. The bank provided loans to its customers. Since then,
developments in the Islamic financing have grown. For instance, in 1960s, Islamic faith
financial practices experienced a revolution when political and socioeconomic factors
merged including the prohibition of usury which is commonly used today to mean an
excessive rate of interest, or riba. Hence, the finance system has progressed based on
faith of Islamic teachings including wealth distribution, social and economic justice, work
ethics and expected responsibilities of the state, individuals, stakeholders and the
society.
The tenets of the Islamic bank are to stand by the sharia laws in interest
transaction, speculations, risks and uncertainties. Furthermore, financing structures
complied with the policy and the religious beliefs of Muslim. Islamic financing objectives
included ensuring equitable distribution of resources to all members of the society,
ensuring resource optimization through financing of affable projects that have economic
implication and social development by creating a fund to help unfortunate in the society.
Others included economic development aimed at boosting the economy, ensuring
stability of money value and ensuring that every Muslim complied with the sharia laws,
whereby, receipt and payment of interest was not allowed.
The five principles that govern the Islamic finance system include riba, which
prohibits payment and receipt of interest, risk and return sharing that allows sharing of
interest and returns instead of charging the interest. Moreover, it requires abiding by the
sharia laws, ensuring sanctity of contract by disclosing all the information pertaining to a
contract and avoidance of gharar or any deceptive activities.
Growth of Islamic finance has been achieved through setting up of transitional
bodies such as Islamic Finance Services Board and Accounting and Auditing
Organizations that have assisted in setting up accounting practices and policies that
have supported the finance to grow. Others include market competition, which has
contributed to production of new ideas, high skills of employees in capital markets,
globalization that has increased the opportunities for Muslim countries and progression
in technology that has ensured easy and effective operations.
Chapter 2: Islamic Law and Financial Services
Islamic religious law/sharia is the basis of the Islamic finance. These laws
promote for fairness and equality in the society by emphasizing to ethical, social, moral
and religious factors. On the other hand, Islamic finance is practiced by Muslim
community and complies with the Islamic rules, codes of practice and principles.
The foundation of Islamic law is derived from the word salaam that means peace.
The roots of Islamic banking and finance are based on religion of Islam and include
three elements: akhlaq, aqidah and sharia. Aqidah is a creed that requires a believer
not to be in suspicion, akhlaq sets out the ethical code of conduct of how they are
supposed to behave, while sharia are laws that govern all aspects of Muslims life
socially, spiritually, politically and economically.
Islamic laws categorize behaviors by nature of actions of people. For instance,
actions are classified as recommended, obligatory, reprehensible, permissible and
prohibited. Every category of action is punishable by Allah. For instance, Wajib is an
obligatory act and is rewarded by Allah; failing to observe acts such as prayers is
punishable. Haram is an action that is forbidden hence attracts heavy punishment. It is
a sin and includes actions such as drinking alcohol and gambling. Islamic laws govern
the actions and behaviors of the Muslim. These laws are categorized into two: main and
minor.
The main source of law is the Quran, which provides guidelines on how Muslims
live and worship. It teaches both divine and external factors of the lives of the Muslims.
The book is holy among Muslim community and it guides the structuring of the Islamic
banking. The book has various verses, which object riba or giving and payment of
interests. It has helped Muslims in setting out their banking principles and policies.
Other main sources of Islamic law are sunnah, ijma, and Qiyas. Minor sources of
Islamic law include Urf, itjihad, istinsan, and istislah.
Another important aspect in the Islamic finance concerns a contract. A contract is
an agreement between two parties. The agreement should be binding, legal, acceptable
and meaningful. Contracts are grouped into three categories; invalid, valid and void.
The Islamic commercial law is applied in the operations of Islamic banking and it deals
with legal ramifications and contract issues.
For the contracts to be binding and transparency, various elements should be
met. There must be an offerer and an offeree between the parties. There should be a
seller who makes an offer and a buyer who accepts it. This can be done either orally,
written, signs or through an agent. There should be a subject matter and consideration,
which should comply with the sharia laws. This should exist at the time of making the
contract and should be deliverable. All the parties should also know the specifications of
the contract.
Sharia laws are classified based on nature and legal consequences. For
instance, those classified under nature include unilateral contracts, bilateral contract
and quasi contract. In unilateral contract, one party makes the contract while the second
party has the obligation to accept or reject the contract. In a bilateral contract, promises
made are bounding to all parties. Example of this contract includes partnerships and
contract of exchange. Quasi contracts are not popular in Islamic law. This contract is not
formal but terms are followed as defined in the contract and are therefore legitimate.
Those classified based on legal consequences include sahih, fasid, batil, lazin, nafidh,
mawkuf and ghayr lazim contract.
In Islamic banking, contracts are important in achieving transparency and
conformity in structuring transactions. A number of contracts are applied in Islamic
banking. These include contract of exchange, contract of usufruct, gratuitous contract,
participation contract and supporting contract.
Contract of exchange is one of the primary contracts that allow exchange of
goods and property for the owner to the buyer at a fixed price or through barter trade.
Contract of usufruct allows a third person to benefit from another person’s property.
Example of this kind of contract is leasing. Gratuitous contracts are entered for charity
or benevolence purposes, whereby, a bank or an individual provides or awards a gift to
someone without commensurate exchange. Participation contracts are risky, reward
sharing and aim at encouraging creation of wealth through partnership arrangements.
Examples include trust financing and partnership financing. Supporting contracts
applicable in Islamic banking include collateralized financing, whereby, an asset is set
aside for collateral payment of certain obligation.
Chapter 3: Islamic Banking: Sources and Uses of Funds
The major sources of funds include trading, leasing and sharing of the risk and
rewards. Most contracts entered are on profit and sharing since they are in tandem with
the sharia laws. For instance, banks may sell their assets to customers through
installments or lease their property for duration of time and attract fixed returns. The
Islamic banking does not carry out or allow fractional reserve banking. This
arrangement allows charge of interest of loans given out, a practice that is not allowed
by the Muslim sharia laws.
The sources of funds of the Islamic banks are from deposits. These deposits do
not attract interest. The sources of funds include savings accounts, shareholders’
investments, investments accounts and current accounts. Investments accounts are
classified as either general or special and may include statutory funds such as treasury
bonds. All these deposits attract profit, which is not a mandatory. The profit distribution
is dependent on the performance of the financial institution.
Funds for these banks are used in meeting or financing shorter as well as longterm needs of the members. The banks provide profit sharing and equity financing. This
ensures that funds are channeled to individual or schemes to steer economic growth. In
equity financing, the bank is allowed to participate in the enterprise’s decision-making
process, while under profit sharing scheme the bank participates in the management
decisions when borrowing takes effect.
Chapter 4: The Islamic Capital Market
Islamic capital marketing is one of the key players in the growth of Islamic
financial institutions in the Muslim world. The primary purpose of this market is to
facilitate or allow individuals, government and companies with surplus funds to transfer
the same to other people in need of such funds. It therefore helps in stabilizing and
regulating the flow of money and acts as a parallel market for the other kinds of capital
markets for capital seekers and providers.
The market attracts funds from both internal and external market. Some of the
international sources of funds for these banks include high net worth individuals or
corporations from oil-rich countries. Business sector is also one of significant contributor
of the funds. There has been a potential increase in the Islamic products due to lack or
prohibition from non-Muslims to participate in the Islamic capital markets.
The origin of the Islamic capital market dates back in 1970s and 1980s when
individuals with high net worth sought for ways to invest their surplus funds they got
from sale of oil. By 2008, the Islamic capital market thrived because of retail demand.
To ensure success and sustainability, the Islamic capital markets had no
obligation to find new competitive products. They introduced equity funds and Islamic
bonds that regained their competition in the markets. They attracted and served nonMuslims by providing numerous products that competed with the conventional financial
products.
Islamic capital market consists of the Islamic equity markets, which comprise of
companies that operate in activities allowed by the sharia. To ensure that the sharia
laws are followed to the later, Islamic stock screening helped to regulate and ensure
that trading was permissible. Revenues derived from activities involving pork, alcohol
and gambling were not considered in the Islamic equity market.
In summary, financial products that did not exist in the Islamic capital market
found their way in the market. However, some products like Islamic hedge funds are still
controversial in many parts of the Muslim community, since the funds are viewed as
stimulating short selling.