Islamic Modes Of Finance

Broadly speaking, Islamic modes of finance can be divided into two types: either they provide direct finance as capital funds through partnership (musharakaand mudaraba), or they provide indirect finance through leasing (ijara) and sale contracts (murabaha, bai ajil, salam, and istisna). All modes are based on the principle of riba (interest) prohibition, and all seek to maintain Islamic business ethics (freedom and leniency of transactions, recognition of and regard for private property, and justice).

Executive Summary

• Islamic finance modes are based on profit/loss sharing because of riba(interest) prohibition.
• Murabaha has been responsible since the 1970s for the employment of about 80–90% of Islamic banks’ resources. The bank provides commodities on a “cost plus profit” price formula to customers who pay back their debt in installments.
• Ijara ranks next in importance after murabaha and implies a promise by the bank (lessor) to gift or sell the leased asset at a nominal price to the lessee by the end of the leasing period.
• Diminishing musharaka is a new product whereby the bank provides capital to a customer or partner whose share in partnership is increased gradually by repaying the principal in installments, plus a share of therealized profits to the bank.
• Salam entitles instant cash to a bank customer against its commitment to deliver prescribed commodities at a future date. Parallel salam, on the other hand, is practiced by banks to hedge their salam operations.
• In istisna the bank finances the manufacturing of a commodity for a customer who pays its price in installments. It is practiced mostly in Gulf countries.
• Islamic financial institutions, in the form of the limited liability joint stock company, rely totally on “ordinary shares” for raising their capital.
• Multiple-party mudaraba has enabled Islamic banks to work as partner/investor on a profit/loss basis for large numbers of capital owners whose deposits take the form of investment accounts.
• Islamic financial institutions have recently extended their activities in capital markets, and sukuk (Islamic bonds) are playing an important role in mobilizing resources.
• Because of riba prohibition, securitization (for sukuk purposes) should neither include murabaha, istisna, and salam assets, which are debt arrangements, nor allow for guaranteed regular payment to sukuk holders. Yet although sukuk experience, has been successful in terms of resources mobilized, it shows deviation from these rules.
• If sukuk do not maintain strict shariah rules they are bound to be confused with conventional bonds.
  
  

  Riba In Quran

  
  
  
  
  

  1. First Revelation (Surah al-Rum, verse 39)

  “That which you give as interest to increase the peoples’ wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold.” (30: 39)

  2. Second Revelation (Surah al-Nisa’, verse 161)

  “And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other peoples’ property. We have prepared for those among them who reject faith a grievous punishment (4: 161)”

  3. Third Revelation (Surah Al ‘Imran, verses 130-2)
  “O believers, take not doubled and redoubled interest, and fear God so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy.”

  Riba In Hadith

  1. From Jabir : The Prophet, , may cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: “They are all alike [in guilt].” (Muslim, Kitab al-Musaqat, Bab la’ni akili al-riba wa mu’kilihi; also in Tirmidhi and Musnad Ahmad)

  2. Jabir ibn ‘Abdallah , giving a report on the Prophet’s Farewell Pilgrimage, said: The Prophet, , addressed the people and said “All of the riba of Jahiliyyah is annulled. The first riba that I annul is our riba, that accruing to ‘Abbas ibn ‘Abd al-Muttalib [the Prophet's uncle]; it is being cancelled completely.” (Muslim, Kitab al-Hajj, Bab Hajjati al-Nabi, ; may also in Musnad Ahmad)

  3. From ‘Abdallah ibn Hanzalah : The Prophet, , said: “A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times” (Mishkat al-Masabih, Kitab al-Buyu’, Bab al-riba, on the authority of Ahmad and Daraqutni). Bayhaqi has also reported the above hadith in Shu’ab al-iman with the addition that “Hell befits him whose flesh has been nourished by the unlawful.”

  4. From Abu Hurayrah : The Prophet, , said: “On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest.” (Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-riba; also in Musnad Ahmad)

  Sharia: Islamic law. Islamic finance thus often is also called sharia-compliant finance.