Key Principles Of Islamic Finance And Its Sources Finance Essay

Islamic finance is one of the most rapidly and wildly turning sector of the planetary fiscal system. The impression of Islamic Finance is basically involvement free fiscal market. Islam allows trade and the understandings which are applied to the footings of workss in the Islamic Shariah. Workss are civil understandings and all civil understandings are allowed in Islamic finance [ 1 ] . Therefore, Islamic finance allows the aggregation of sedimentations and use of resouces through understandings allowed in the Shariah.

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Shariah/Islamic Law

Shariah is a manner or way harmonizing to the guidelines and commandments written in the Holy Quran, the Sunna ( expressions ) of the Prophet Muhammad ( Peace Be Upon Him ) . It is further appended by the jural apprehensions by Islamic intellectuals [ 2 ] . Shariah expresses every facet of the human life, religion and patterns. Islamic Shariah is derived from the following four of import beginnings:

1. Holy Quran

2. The Sunnah ‘ ( Sayings ) of the Holy Prophet ( Peace Be Upon Him )

3. Ijma ‘ ( Ummah ‘s consensus )

4. Qiyas ( Anology )

Principles of Islamic Finance

Islamic finance has intent of doing money by supplying out investing. However, this is non wholly the lone intent, either. The nucleus of Islamic banking is in the attachment to Islamic jurisprudence and guaranting just drama. Islam prohibits merely supplying hard currency at involvement [ 3 ] . The Muslim waies are generated to avoid this ascertained immoral/evil. The Islamic finance rules are built on risk-sharing which is the cardinal component in trade. On the other manus, risk-transfer observed is conservative finance. Islamic finance nowadayss thoughts such as gross sharing ( Mudharabah ) , safekeeping ( Wadiah ) , joint venture ( Musharakah ) , cost plus ( Murabahah ) , and renting ( Ijar ) .

Concept of Islamic Finance in Sharia

Islamic finance construct is based on Islamic criterions such as morality, equality, rationality, and justness. In Islamic finance, societal duty to the community is more of import than maximising the net income or return on investings. Islamic finance besides involves a will to portion the effects: participants may gain net income every bit good as bear losingss, as per pre-determined ratio.

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Therefore, an honest purpose to take duty is the foundation of any Islamic concern agreement [ 4 ] . A description of the four most common interest-free funding constructs based on the Shari’ah are as follows.


Ijara, or leasing, is really common in most of the fiscal systems. The chief difference in Islamic leasing involves the finding of the rental cost. Islamic finance rental payments are determined by the profitableness of the implicit in merchandise.


Islamic fiscal establishments normally use murabaha, or installment purchase. Murabaha is simple and easy to construction, nevertheless has restrictions particularly in long-run funding because once the installment period is fixed, it can non be changed. No price reduction for paying an early installment. Therefore, Muslims have flexible replacement such as musharaka.


Musharaka, or partnership funding, is a well-known construct in Islamic finance. A musharaka contract have a fixed or flexible term. The common understanding between the parties decides profit- and loss-sharing ratio.


Mudaraba ( labor- and capital-partnership ) is similar to musharaka. However, the difference between the two is that in mudaraba one party contributes in the signifier of labour while the other will supply capital. The capital provider bears the loss in instance it happens, while the labour provider loses his or her chance cost merely.

Main types of minutess that are prohibited under Sharia

The Islamic Finance rules are:

The bar in taking or giving involvement at inordinate charges ( Riba ) , nevertheless, this act does non forestall charges of net income on assets and mony.

Threat/Profit in trade/business must be shared, i.e. between investor and the bourgeois.

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The bar of projected behaviour ( Gharar ) , intending that gaming/beting ( Maysir ) .

Investing is a possible capital which has to be used in a productive capacity. Other investing guidelines given as follows:

Finance in concerns whose mean market capital is greater than 33 % of the entire debt divided by draging 12 months.

Finance in concerns whose mean market capital is greater than 33 % which is amount of hard currency plus involvement and so divided by 12 month.

Finance in concerns whose history receivables divided by entire assets are greater than 33 % .

Finance i.e. against the guidelines of Shariah. All Shariah boards prevent investings in non-ethical concerns i.e. , spirits, jambon related merchandises, traditional investings with involvement, merriment ( wagering and cabarets, motels, film, erotica, music ) . Some Shariah boards besides recommend against narcotics, munitions and military.

Function and construction of Sukuk

Sukuk is a signifier of a Bond which is shariah compliant. In simple words, the sukuk characterizes ownership of an investing. The sukuk is non merely a privilege of hard currency flow but an ownership privilege. The sukuk is different from normal bonds, i.e. conventional bonds with involvement,

whereas sukuk give ownership to the assets issued as investing certifications [ 5 ] .

Sukuk were often used in ancient times during Middle Ages by Muslims for trade and other commercial workss. However, todays organisation of sukuk are significantly unlike in the procedure in which ownership of any investing is allocated to many investors, through sukuk in proportion of the pertinent belongingss.

Functions of Sukuk Fundss

Three most of import maps of sukuk can be:

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1. Project-specific Sukuk

When money is raised through sukuk for specific undertaking e.g. Qatar Global sukuk was issued by the Regime of Qatar, 2003, in order to raise investing for the edifice of Hamad Med. City, Doha.

2. Assets-specific Sukuk

When investings are mobilized from beneficiary rights of the belongingss e.g. Malayan Govt. roll up US $ 600 million with the aid of Ijara sukuk known as Trust Certificates ( TCs ) , 2002. Under this agreement, the right of the land packages were sold to investors for five old ages [ 6 ] .

3. Balance Sheet-specific Sukuk

When resouces are mobilized for many undertaking in different states e.g. such sukuk financess was done by the Islamic Development Bank ( IDB ) sukuk which was distributed in 2003. The IDB organized these investings to endorsing assorted ventures of the fellow provinces. The IDB raised its resources from the international investing market by administering US $ 400 million 5 twelvemonth sukuk.

Structures of Sukuk

The most common Sukuk constructions are based on the type of Islamic methods for investings.

1. Mudaraba Sukuk

These types of sukuk provides a signifier of ownerships to the investors of units. These units are of equal value and are registered with their proprietor names and its returns, harmonizing to ownership portion. Rabbul-mal is the name used for the proprietors of such sukuk [ 7 ] . Public engagement in large undertakings is enhanced by utilizing such sukuk. Its construction is as follows:

The undertaking proprietor will hold understanding with Mudarib.

Particular purpose vehicle ( SPV ) is responsible for issue of sukuk.

Mudarib will roll up regular income and concluding investing for onward distribution.


After the completion of the undertaking, Mudarib will present the it to the owner.

2. Musharaka Sukuk

ownership of Musharaka nonpartisanship is another sort of investing sukuk. It is similar to the Mudaraba sukuk. However, with different relationship i.e sukuk publishing authorization and investors. They are used to raise investings for a new venture or germinating an current one or puting a trade activity. These certifications can besides be retailed in the secondary market. Its construction is as follows:

Corporate contributes physical assets e.g. land, to the Musharaka.

SPV contributes mony received from the investors to the Musharaka

In order to develop the physical assets, the Corporate is appointed as an agent.

In return, the agent will acquire a inducements and proprietary fee.

The net incomes are dispersed to the interest proprietors.

3. Ijara Sukuk

These sukuk are produced in ownership with equal portions, particularly in real-estate rented environment. This will give ownership to rented real-estate, receive the rent and dispose. The interest proprietors will digest all charges of care and devastation to the existent estate [ 8 ] . Its construction is as follows:

The obligator retails some belongingss to the SPV at an sanctioned pre-determined approved monetary value.

The SPV collects money by administering sukuk in equivalent to the sanctioned monetary value.

SPV and the obligator signed an understanding for fixed clip period.

The obligator will supply monthly payments to the SPV.

These are dispersed among the shareholders i.e. the investor.

At adulthood, the SPV trades the belongingss back to the bargainer at a sanctioned value.

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4. Murabaha Sukuk

In Murabaha sukuk, the issuer of the certification is the agent of the merchandise. The purchasers of this merchandise are endorsers and the investings are used to buy trade good [ 9 ] . The investors own the Murabaha merchandise and are permitted to re-sale. Its construction is as follows:

SPV purchase merchandise on spot footing from the merchandise provider.

SPV and the borrower will subscribe a maestro title.

The borrower retails the merchandise to the Product purchaser on topographic point footing.

SPV distribute sukuk to the investors and cod sukuk proceedings.

SPV retails the merchandise to the borrower at the topographic point monetary value plus a net income border.

The investors collect the concluding minutess.

5. Salam Sukuk

These are certifications of equal value, issued for raising Salam capital. The certifications issuer is a marketer of the goods of Salam. However, the endorsers are the purchasers of the goods. The investors of Salam are besides the owners of the Salam goods [ 10 ] . Therefore, they are authorized to the sale the certifications or goods. Its construction is as follows:

SPV and an obligator marks an project to beginning both ownerships and buyers.

Salam certifications are delivered to investors.

obligator will provides supplies to SPV.

Obligator can sells the supplies for a net income.

Differentiation between the conventional and Islamic banking systems:

Conventional Banking

Islamic Banking

Money is a signifier of trade good which can be sold at much higher monetary value than its face value and it can besides be rented out.

Money is non a trade good which can be sold at a monetary value higher than its face value or rented out.

The involvement is charged on investing on the footing of Time value.

Net income is obtained on trade of goods. Net income can besides by earned by supplying services.

Interest based investing where involvement is charged irrespective of net income or loss. The investor does non portion losingss by utilizing Bankss financess. Therefore, it is non based on net income and loss sharing.

Islamic finance operates on the doctrine of net income and loss sharing. The investor will hold to portion losingss if man of affairs has suffered losingss and such portion will be based on the manner of finance used ( Mudarabah, Musharakah ) .

In this banking, no understanding for exchange of goods & A ; services can be made, while pay outing hard currency finance, running finance or working capital finance.

In Islamic banking, the understanding allows for the exchange of goods & A ; services, while pay outing financess under Murabaha, Salam & A ; Istisna contracts.

Conventional Bankss use money as a trade good which leads to rising prices.

Islamic banking creates link with the existent sectors of the economic system by heightening trade related activities. The money is linked with the existent assets therefore it contributes straight in the economic development.


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