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Comprehending the Islamic Finance system

In the contemporary world, one cannot deny the importance of the strong economy for the wellbeing of the common people. As the modern world has become a global village, no country can afford to have a solitary economic system to succeed in this inclusive economic world. The modern economic system is based on a set of financial activities to drive the national economy. This western economic system is an interest-based economic system where “interest” is the main motivation behind investing money and taking financial risks. On the contrary, our religion Islam is strictly against the financial transactions involving interest or “Riba” and emphasizes the importance of interest-free economy.

Does it mean that Islam does not provide guidance for the modern complex economic system or we need to understand the teachings of the Islam in the modern perspective to develop a valid and reliable alternative to compete in the emerging modern economic systems? Of-course better understanding of the Islamic financial system is the way forward. We should resort to the main sources of the Shariah for the guidance to develop the modern Islamic economic system to survive in the prevalent cutthroat economic competition. There are two main and primary sources of Shariah the Holy Quran and the Sunnah of Holy Prophet (PBUH). Ijtihad is the third source of Shariah. Ijtihad means deriving rulings of new issues from the general guidelines of the Quran and teachings of the Prophet Muhammad (PBUH). Based on these three sources of Islamic law the Muslim jurists and economist have suggested a complete set of guidelines for Islamic Finance. However, this article would look upon the current Islamic economic systems vis-a-vis the western economic systems with regard to the modern corporate world. The purpose is to give an understanding of the Islamic Finance to the common people and the students interested in understanding Islamic Finance and expand their perspective. We will discuss the six major elements of the Islamic Finance, which are vital to run the modern economy and corporate system:

  • Mudaraba: It is a kind of partnership between a person, called Rabb-ul-Maal who provides capital for investment, and the other person called Mudarib, who has expertise in business and invests this invested capital in some commercial venture to earn profits. This also describes an Islamic way of keeping bank accounts, whereby the banks share their profit with the bank account holders. This also provides answer to the questions whether Islam allows us to have a profit sharing account in banks, and can banks take profit on their loans granted to the business persons.
  • Murabaha: It is a type of cost plus financing. It is contract for the purchase of some asset whereby buyer and the seller agree to some cost plus or profit arrangement. The purchaser does not become the true owner unless the total loan is paid. For example in a Murabaha mortgage the borrower selects a house for purchase, the lender bank buys that house and resells this house to the borrower at an agreed high price to be repaid in monthly installments. The Murabaha mortgage generally extends to a maximum period of 15 years as such the repayments can be quite high. Importers can also open Murabaha Letter of Credit.
  • Ijarah: This is a term borrowed from the Islamic Fiqh to be used in the Islamic Finance. Ijarah means to transfer the usufructs of a particular property to another person in exchange for an agreed rent. This is equivalent to the leasing. In Ijarah the lesser is called “Mu’jir”, the lessee is called “Musta’jir” and the rent so payable is called “Ujrah”. In case of an Ijarah Mortgage, the mortgagor enters into two agreements with the mortgagee bank that buys the property for the borrower; one that he will pay back the purchase price of the property to the bank in the agreed fixed monthly installments and second for the payment of the monthly rental to be determined annually. This is comparatively a long-term loan as compared to Murabaha Mortgage.
  • Musharika: In the simplest terms, Musharika is an Islamic way of establishing a joint enterprise or partnership. In Musharika all the involved parties contribute their respective funds towards a commercial venture. The parties share profit in a predetermined ratio. However, the loss is shared in proportion to the respective contribution of each party. Management of the venture can be carried out by all, some or one of the parties as may be mutually agreed. However, due to certain operational complications it is a rarely applied banking practice.


  • Takaful: An Islamic alternative to the conventional Insurance system is Takaful wherein all the members contribute funds called Takaful Funds in a pool system to guarantee each other in case of loss or damage. Each participant’s contribution is based on the type of coverage they require. The Takaful Operator, on behalf of the participants, manages Takaful Funds. Takaful Operator charges an mutually agreed upon fee to cover costs Takaful is in commercial practice since 1979 when first Takaful company in the name of Islamic Insurance Company was established in Sudan. Pakistan promulgated SECP Takaful rules in 2007 paving way for the Takaful Companies in Pakistan.
  • Sukuk: It is an Islamic version of the conventional bonds in the Islamic Finance system. Sukuk is a type of hybrid securities having the characteristics of both stock and the bond. Public Offering Regulations 2017 defines it as: “Sukuk” means an instrument of equal value representing undivided share in ownership of the identified tangible assets, usufruct and services or in the ownership of the assets of particular projects or special investment activity. A Sukuk holder is entitled to receiving periodic profits on the amount so invested, and will get his principal amount of investment back upon maturity of the Sukuk.

If we go through the nature of different financial instruments/transactions of Islamic Finance, distinction of the Islamic Finance from that of Western Financial system apparently appears to be based on the use of the Arabic Islamic sounding terms. It appears to have just a different nomenclature with the same economic substance. This criticism is not baseless, but poor understanding of the teachings of Islam might be a reason. It is the Niyyah (intention) that matters in Islam. Take the example of the slaughtered animals, the animals slaughtered without saying the name of Almighty Allah are forbidden despite being slaughtered in the same way. Islamic banking is relatively a new concept commercially put into practice in 1975 by the establishment of an Islamic Bank in Dubai. It is still in early stages, going through fine-tuning and enhancements to make it more practical in the modern economic world.

Mr. Tarek El Diwany, a London based critic of Islamic Finance has put it as “If Islamic Banking adopts a genuinely Islamic paradigm it can offer a solution to a world hungry for alternatives. If it does not, it will enjoy a brief life as a get-rich-quick bandwagon and then disappear into the relics of financial history.”

(The writer is a sales and business specialist based in Islamabad. He can be reached at nadeem_naj@hotmail.com)

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