Islamic finance denotes the process by which organizations of Muslim origin such as banks and other credit institutions raise money in accordance with Islamic laws, which are also referred to as Sharia regulations (Kettell, 2011). This phrase is also used with respect to business investments that are acceptable under Islamic laws. It is a peculiar type of socially responsible investment in that the Islam religion does not discriminate anyone on the basis of spirituality or secularity, hence its venture into the field of finance is versatile. Despite the fact that it is an upcoming sector, Islamic concept of economics has existed for a very long time. During the middle of the 12th century, numerous scholars who professed the Muslim faith had in fact proposed major concepts of Islamic economics that are still relevant in contemporary times. For a long period, social as well as political mayhem has interrupted its growth and this sector began receiving much attention from the 20th century.
Taking a Loan in Islamic Banks in U.A.E.
Islamic finance is founded on the teachings outlined in the Quran which states the foundations of Sharia regulations. According to this law, money has no inherent worth. Instead, it can only be used as a medium of exchange. This means that money should not be used to generate more cash, but it should be utilized in the course of legal dealings concerning goods and services.
The provisions of the Institute of Islamic Banking and Insurance stipulate that as a matter of belief, a person professing the Muslim faith should not grant credit advances to or receive finances from another person with the expectation of drawing benefits through interest, which they also refer to as riba. This policy also applies when borrowing funds, since the creditor benefits from the interest charged. Therefore, in order for any credit advances to comply with Islamic law, the loan should be Qard, which means that it should not have profit driven motives (Bley & Kuehn, 2004).
Taking a loan from an Islamic bank involves the formation of a business contract between the banker and the debtor. The borrower manages the business as the banker oversees it. In one way or another, the benefits gained as a result of using the credit advance are shared according to fixed rates prior to the formation of the agreement. In this case, what makes it different from other banks is the fact that the percentages used to establish the profits need to conform to Islamic laws, and a copy of the percentage quotation agreed on should be sent to the UAE Central Bank for publication. The Islamic bank may also make provisions for services and charge money.
There are various types of loans classified as interest-free loans which meet the criteria laid down by Islamic regulations (Wilson, 2012). They include among others the time multiple counter loans, where a customer who is needy can be granted cash advancements devoid of making any interest payments to the bank. Other types of loans free of interest which fall under this category include a normal rate of return cash loan, inflation based loan indexation, overhead charge on loan and education loans.
Due to the reasons deliberated on previously, in the Islamic banking division, there is no ideal lending business, because all creditors receive their ownership interest on the property that they finance, or obtain a proportion of the profit as a fee based compensation. In order for an Islamic bank to earn any profit from the cash that they lend to their borrowers, it is essential for them to acquire an equity or possession interest in an asset that is not monetary in nature. In such a case, the lender should also bear a portion of the associated risks.
Buying Real Estate in Islamic Banks in U.A.E.
Most Islamic banks have dedicated their efforts to the real estate sector due to the fact that it complies with the preset Islamic principles, which stipulate that there should be an underlying tangible asset in each transaction (Wigglesworth, 2009).
There are three major types of Islamic agreements for purposes of buying real estates in Muslim banks. These contracts are free of any riba or interest charges on the mortgages. The contracts include Murabaha, Ijara and Musharaka (Wilson, 2012).
In the first contract, the bank purchases the estate and then sells it to a customer at an elevated price, which is returned in installments. Ijara contracts are formed when the bank buys the property and leases it out to the person who purchased it. The buyer makes payments which cover the purchase of the equity in installments and rental fees for the utilization of the amount of equity still belonging to the bank. Musharaka, on the other hand, is also a famous method of mortgage financing for Islamic banking institutions. This type of contract occurs where the bank takes part in the sharing of profits as well as losses of a business venture for a specific period of time. A diminishing Musharaka agreement denotes a mortgage deal in which the bank’s stake decreases, while that of the customer increases over a particular period of time. Eventually, the ownership passes to the debtor.
Murabaha has been condemned by various Islamic academicians for the reason that it acts as a method of concealing the charge of what is essentially a fixed interest. The Ijara contract has also attracted similar criticisms, because it appears to give a bank the opportunity to alter repayments under the agreement.
Joint Investment between Islamic Bank and an Individual
The economic principle of Islamic banking offers a middle ground between extreme capitalism and communism. The investment relationship provides an individual with the liberty to produce and create wealth while subjecting him to an environment controlled by the divine guidance of Allah. This environment sets the rules and norms, which require utmost sincerity of intent, which, when acted upon by both parties, produces peace and prosperity for the whole society. The relationships between Islamic banks, individual persons and corporates in terms of investment are grounded on several principles, which will be discussed in the subsequent paragraphs.
The first principle is trusteeship, whereby the Quran postulates that a man is just but a trustee for the wealth bestowed upon him. This principle introduces a moral and spiritual element into commercial relations which include banking. Secondly, there is the principle of care for others. Under this principle, the perpetration of self-interest at the expense of others is prohibited. This implies that individuals are not permitted to create wealth by charging interest on others and reduction of charitable donations. The application of Sharia rulings to business forms another essential in relations between individuals and Islamic banks. These rulings of the Holy Book are aimed at removal of all ambiguities and misunderstandings of agreements which facilitate commercial relations. Sharia law forbids the charging of interest on individuals for commercial transactions and advices that contacts which regulate financial matters should be put in writing (Wilson, 2012).
Another basic tenet of commercial relations between individuals and Islamic banks is mutual consultation. This principle postulates that a man is free to enter private contracts, but decisions concerning the general society’s well-being should be made on the basis of consultation. It in short disallows dictatorship. Another principle is the treatment of wealth as a means and not as an end. Beyond satisfaction of the primary needs of a human being, the ultimate aim of making and spending money ought to be moral and spiritual. The use of wealth for such purposes as gambling, exploitation or borrowing and lending for an interest is specifically prohibited in Islamic Banking. Similarly, the formation of cartels and monopolies by individuals is prohibited by Sharia law. Another principle forming the basis of Islamic and individual relations is Zakat. Zakat is a charge on certain types of wealth. This charge is compulsory on Muslims only and it applies to savings, agricultural harvests, certain kinds of jewellery and agricultural produce. It can be deducted by either the government or the bank on behalf of the government, and it perfectly serves the concept of wealth redistribution as well as social insurance. Last but not least of these principles is the principle of Qard Hasan, which means interest-free loans. Such loans are to be used majorly for purposes of productive economic enterprises so as to establish poor people in trade in agriculture.
Profit sharing (Mudarahaba) entails an arrangement whereby the bank (rabb-ul-maal) provides financing to an individual entrepreneur to pursue business activity. Any profit generated from this business activity is shared between the bank and the entrepreneur according to a pro-rated ratio, while any losses incurred are suffered solely by the bank. The reason for this apparent unfairness is because the entrepreneur is deemed to have lost time and hard work put into the enterprise. If, however, the mudarahib has acted with negligence or caused the losses willfully, he will be liable for such losses. A key feature of this relationship is that it is only the mudarahib who has the right to participate in the management of the business. In terms of liability, the financier’s liability is limited to the amount of capital invested, and any extra liability is borne by the mudarahib. It is also important to note that any commodity that is being traded by the business is owned by the bank, and the entrepreneur is only entitled to income only when he makes profitable sales.
Generally, there exist two types of Mudarabah depending on the rabb-ul-maal’s wishes. Where the financier restricts the entrepreneur as to the kind of business he or she can conduct, the arrangement is known as a restricted mudarahaba or al-mudarabah al-muqayyadah. Where the financier fails to impose any restrictions on the mode of business to be conducted by the trader, the deal is known as unrestricted mudarahaba or al-mudarabah al-mutalaqah (Kettell, 2011). In each of the above-mentioned arrangements, the amount of profits to be shared by the two parties is agreed between them, and this figure must solely be dependent on the profits that will be generated from the entity, as opposed to the amount of cash invested. In accordance with Islamic law, the parties are allowed to agree on the ratio of profits provided they do not peg it to the capital, since that will be deemed to be a return on the cash pumped into the business. Another important feature of this relationship is that either of the partners to the agreement may end the relationship at any time as long as they provide sufficient notice.
Joint Investment between Islamic Bank and Corporation
The concept usually applied in this case is known as a Musharakah, which denotes a joint venture or business partnership (Wilson, 2012). This model is utilized in place of interest bearing loans. In this partnership, the gains made from trade are distributed between the partners at an agreed ratio. The losses made, on the other hand, are based on the ratio of contribution of capital into the venture by the two parties. It is distinguishable from the mudarabah in the sense that capital put into the enterprise is contributed by both parties. In addition, unlike in mudarabah, all partners can engage in the managerial affairs of the concern. Another feature of the musharakah is that the liability of partners is unlimited, and in the event of liquidation all the partner’s private assets will be used to satisfy the excess debt. A further feature of this kind of arrangement is that all the properties of concern are mutually owned by the partners in accordance with their contribution ratio. These kinds of partnerships usually result in two kinds of funds, which include equity fund and commodity fund.
Equity funds are the purest form of musharakah, where the capital contributed by both parties is invested in the shares of public limited companies. Profits from such ventures usually have the form of capital gains, whereby the shares are purchased at low prices only to be resold when their prices will have increased. Dividends distributable by the companies also form part of the profits of the ventures. There is, however, a restriction on the companies in which shares can be invested. According to Sharia law, such a company should neither borrow money on interest nor invest its surplus funds in an activity which generates income.
Generally, there are two forms of equity financing. One is the permanent musharakah, where the Islamic bank provides equity financing for a venture and receives a profit with respect to the profit sharing agreement. The duration of this contract is usually unspecified and thus suitable for projects in which funds have been committed for a long period. Another form is diminishing musharakah, whereby profits from the venture will be shared in a pro rata basis. The formula via which the Islamic bank will keep reducing its amount of interest invested in the project and eventual transfer ownership of the venture to the corporation is provided. Such a deal provides for the payment to the bank of a greater share than the amounts due to it and ultimately buying the bank out.
In a commodity fund kind of financing, the bank and the investing partner contribute funds which are used to purchase different types of goods for the purpose of resale. The profits generated from the purchased merchandise are distributed on a pro rata basis between the joint investors. For these profits to be acceptable, they must be Sharia compliant and meet the following criteria concerning the rules regulating commercial relations. First, the seller of the good must be the owner, that is, sales made before a person becomes an owner are prohibited. Next, the goods being sold must not be outlawed - for instance alcohol, pork, among others. Thirdly, in addition to being in possession of the goods, the seller must be the constructive owner of those goods. Lastly, the selling price of the goods has to be determinable and cognizant to both parties to the sale. In addition, such price must not be contingent upon certain outcomes. If commodity transaction is legitimate and meets the above conditions, then a commodity fund may be established.
From the above discussion, it can be noted that Islamic financing that is predominant in the U.A.E. has some unique features that differ from the normal methods of financing. It is based on principles from the Quran, which prohibits making money from lending activities, and, therefore, the loans of their banks are interest-free. Additionally, the money lent to develop real estate property is also subjected to the same principles. In relation to the business, the amounts advanced to corporations and individuals to carry out business activities are also subjected to the rules of Sharia law with modifications, which give the financier some degree of control over the venture. Islamic financing is, therefore, a promising sector that other non-Islamic entities and individuals ought to consider.