WELCOME TO THE WORLD OF ISLAMIC
FINANCE
By Arshid Idris Solicitor 2nd February 2012
In our property department, we have been acting for people
buying their homes with Islamic finance (IF) for many years.
I recently came to know that Faizal Manjoo was in the area,
so I asked for a meeting with him. I was very excited when he agreed as it was
an opportunity to learn more about this fascinating, though complex topic.
Originally from South Africa, Faizal Manjoo is a rare breed
in that he is qualified both as an Islamic scholar and as a solicitor. He is
now based in the UK and is presently studying for his PHD at Markfield
Institute of Higher Education where he is a lecturer and researcher in IF. He
is also a consultant to one of the magic circle of law firms in the city of
London. I found him to be a man gifted with a sharp mind and a great thirst for
knowledge and learning.
Arshid Idris:
What is IF and how does it differ from other types of finance?
Faizal Manjoo: IF is part of the Islamic economic
system. Islamic finance has spread in three main areas: Islamic banking,
Islamic insurance (Takaful) and the Islamic capital market.
IF differs from conventional finance in 3 key
aspects. First “Riba”, which is interest. Then, there is “Gharar” which means
excessive uncertainty. Thirdly, there is “Maysir” which includes gambling and
the like. You will find some or all of these in conventional finance but they
are prohibited in IF.
The sources of IF are the Quraan and Sunnah (the
practice of the noble prophet Muhammad, who himself was a successful merchant).
Hence, Islamic financial contracts are highly regulated. Accordingly, with IF,
the contracting parties do not have the absolute freedom to contract on
whatever terms they want so far as the financial terms are concerned. Whereas
in conventional financing any type of product can be structured even though it
can be ethically wrong.
Essentially, IF is designed to prevent economic
unfairness.
Arshid Idris:
Are there any advantages of using IF?
Faizal Manjoo: Yes, there are several advantages,
including that IF is more socially responsible. For example, “Zakat”, which is
an Islamic levy aimed at alleviating poverty.
IF is more ethical – an Islamic bank will not
finance an operation such as a casino.
IF gives economic identity to the Islamic
community.
Significantly, Islamic banking for instance offers
mainly asset – backed products which have intrinsic value and not debt-backed
products (money for money), as is the case with conventional finance.
Arshid Idris:
Is IF available to everyone?
Faizal Manjoo: Yes, IF is available to the whole
community regardless of faith, as long as the finance is used according to
Islamic principles.
Arshid Idris: Can you please explain about IF in
relation to the purchase of land and property?
Faizal Manjoo: Unlike conventional finance, IF is
designed to delay immediate outright ownership for the customer as IF requires
that the bank takes the risk of the property until ownership is transferred to
the customer.
There are presently two main schemes
available. The first involves the bank
buying the property and leasing it to the customer with an option for the
customer to buy the property after a set term. This is known as “ijarah wa
iqtina”. So the bank bears the risk attached to ownership until all the rentals
are paid for a set number of years. After that the client is given an option to
buy the property or house at a far lesser price than the market rate. This product
is different from higher purchase which includes two contracts in one contract.
The other scheme involves a shared ownership
between the bank and the customer. This is known as a “diminishing partnership”
or “mushrakah mutanaqisah”. Both the bank and the customer contribute equity
towards the property and the bank holds a bigger share in the beginning as it is
financing the said property. Hence the bank initially owns the bulk of the
equity. The customer who would reside in or use the said property will pay
rentals for benefiting from the share of the bank in the property. Part of the
rental paid will technically be considered as an investment towards buying the
share of the bank over a certain period of time. Mathematically the share of
the bank decreases with the passage of time due to the rental paid and the
partial transfer of ownership. Over a certain period of time, the entire share
of the bank is transferred to the customer. Often a trust is used for such a
product to protect both the client and the bank.
Also, there was a model developed in the early
1980’s called the “Murabah”. This is technically a sale with a deferred payment
facility whereby the bank will buy the property and then sells it to the
customer on a deferred payment basis. The cost price and profit are known to
the client. The customer will then pay by instalments over a period of time. However,
the disadvantage of this model is that according to the Islamic law of contract,
the sale price cannot be adjusted. Once a commodity is sold, the price cannot
be changed. Hence there is no roll-over as in the case of a debt-financing
transaction. This is not in favour of the bank.
Arshid Idris:
How do you see IF developing in the foreseeable future?
Faizal Manjoo: IF is expanding very fast at a
consistent rate of 15%.
The IF market is worth 1trillion dollars presently
and is expected to hit 4 trillion dollars in 4 years time. So it is clear there
is an increasing market demand for IF, especially, in the emerging economies
and in the Muslim world. The exponential growth can be explained by the
awareness being created in the community and also a rise in the middle-class
populace in many Muslim countries.
The conventional finance markets have suffered
very badly since the 2008 credit crunch but hardly any IF activities were
affected because IF is not based on debt or other toxic assets. This shows that
IF is a very resilient product.
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