Islamic Finance: Principles and practice

Rachida Talal-AzimiRachida Talal-AzimiPhD CandidatePhD Candidate

It is the Economy, Stupid 5: over Gharar, Riba en Murabaha | 9 October 2012

“What we need is the application of Islamic finance principles, in particular a strong

preference for profit-, loss- and risk-sharing

arrangements and a rejection of ‘riba’ or

interest-bearing debt instruments.”

Financial crisis

Willem BuiterChief Economist, Citigroup (US)

1980s Commercial Banking+ Project Finance+ Syndicates

1990s Commercial Banking Project Finance Syndicates+ Equity+ Sukuk al-Ijara+ Fund Management

2000 and beyond CommercialBanking Project Finance Syndicates Equity Sukuk al-Ijara Fund Management+ Several Sukuk models+ Islamic Microfinance

1970s

Commercial Banking

Development

Source: Thomas et al.(2005) Structuring Islamic finance transactions

Development

What is Islamic finance?

‘The discipline to perform financial transactions in accordance with the principles of Islamic law.’

What is Islamic Finance?

Establishment of an Islamic Economic Thought

Fundamentals of Islamic financial products

• No investments in prohibited companies and/or products

• Encouragement of trade

• All transactions must be asset backed

• Mandatory independent Sharia board (Islamic supervisory board)

• Islamic Window!

Other prohibitions / principles

Wat is islamitisch financieren?

Handel drijvenHandel drijven

Asset basedAsset basedWinst- & verliesdelingWinst- & verliesdeling

Onafhankelijke shari’araadOnafhankelijke shari’araad

Islamic financial instruments

Partnership contracts

• Muđāraba (type of limited partnership)

•Mushāraka (type of equity participation)

Islamic financial instruments

Real estate Bank

Customer

1

2

3

1 Down payment 10.0002 payment 90.0003 10 % of the units4 90% of the units5 rent*6 Unilateral commitment to purchase remaining units7 purchasing contract / sales contract re units

4

567

Mushāraka (type of equity participation)

Islamic financial instruments

Mark-up contracts

• Murābaħa (mark-up contract)

• Bayc Salam (sale by advance payment for future delivery, i.e. buyer credit)

• Istisnāc (production contract)

Islamic financial instruments

Goods for cash

Murābaħa basic contract

Purchase sale

Islamic financial instruments

seller

financier

buyer

1

2

3

4

Murābaħa finance

13

Islamic financial instruments

Other contracts

•Qarđ al-Ħasan (no-interest loans)

•Ijāra (leasing) ijāra wa iqtinā’ (hire-purchase)

•Şukūk (Islamic investment certificate)

Conclusion

What is Islamic finance?

‘The discipline to perform financial transactions in accordance with the principles of Islamic law.’

In other words, more than just a ban on interest!

A system based on a completely different approach to the trading of money than the traditional system

Conclusion

Rapid development of Islamic financial sector

Niche market

Not yet fully developed

Growth is undermined by a number of tough challenges, including:

•Lack of standardisation•Lack of qualified staff

Financial crisis has both a positive and a negative impact

Thank you for your attention!