Wednesday, March 09, 2011

What is Islamic Finance and How is it different from conventional finance ?

Islamic Finance is a form of finance that is based on Shariah, or the body of Islamic law. Shariah means "the path to the water source". Shariah is filled with MORAL purpose and lessons on the truth, and is hence more than just a set of legal rules. [1]

Shariah represents the idea that all human beings and governments are subject to justice under the law. Islamic law covers bigger scopes compared to conventional finance. Islamic finance has overarching requirement whereby every financial transactions must be shariah-compliant. To ensure that, five key prinsiples are strictly followed :

Belief in Divine Guidance - The universe was created by Allah and He created on earth to fulfil certain objectives through obeying His commands. These commands covers a substantial area of almost every aspect of life, including economic and financial transactions. Man needs such divine guidance because he does not have the power to reach the truth on his own. Not only is man imperfect, but also his 'reasons' are often confused with 'desires'.   

In conventional financial system, religion and government are kept separate and independent of each other. This is to uphold religious freedom and secularity in government (such that it is not influenced by any particular religion)

No Interest - You cannot earn interest on a loan or be required to pay interest on a loan. 

In conventional financing, this is like borrowing money from the bank and not having to pay a cent of interest. Islamic banks of course do not loan you money for free. If you were to obtain an Islamic loan for a project, instead of being charged interest for the loan, you could be paying fees or sharing a portion of your profits from the project with the bank

No Haram Investments - Money is to be invested in worthly causes, while companies that manufacture haram products like alcohol, tobacco, arms or pornography are avoided. 

This is similar in some ways to the conventional concept of socially responsible investing (SRI), which seeks to maximise both financial return and social good. Some practitioners of SRI abstrain from businesses similar to those that Islamic ventures would avoid

Risk sharing is encouraged - The idea of risk sharing is conscientiously promoted and regularly practised between business partners, such as between a customer and a financial institutions. For Islamic institutions, risk sharing is favoured in business dealings with its customers. This fosters the equitable distribution of risk, profits and losses. It also covers not only the creditworthiness of the customer risk sharing, but also the financial viability of the project. 

Risk sharing is meant to promote mutual trust and fairness in dealings among business partners, institutions and consumers. 

Financing is based in REAL assets - Financing extended through Islamic products can only expand in step with the rise of the real economy, thereby helping to curb excessive speculation and credit expansion. 

Conventional financing system typically based on the promise to pay where real assets are not tied to the transaction. This means that conventional financing activity can grow several steps ahead of the real economy, thereby causing speculation and UNJUSTIFIABLE asset price inflation

Islamic Finance is for all (muslim and non-muslim)

ref : 

Islamic Finance, Why It Makes Sense, Daud Vicary Abdullah and Keon Chee, Marshall Cavendish Business. 2010. printed in Singapore. 

To buy this book, please contact me. Recommended Price is RM69.90.   


Metamorphiction said...

I had no idea this existed. Thanks for the info.

Mohd Farhan & Dr Rosmawati said...

ok. :)