Islamic Finance - Shariah compliance as it relates to the stock market
When compared to the equity market, Islamic finance and conventional finance are more easily distinguished by banking and insurance products as well as fixed income instruments due to the stricter regulations that govern Islamic finance. Conventional banking and fixed income instruments are mostly based on interest, but the conventional insurance contract is based on the sale of an indemnity in exchange for a premium that contains a significant amount of unpredictability. Interest is the primary foundation of both of these types of financial products. The gap between Islamic and conventional equities markets is, however, not as cut and dry as one might think. This is due to the fact that the aspects that are forbidden are not included in the framework of the individual contracts but rather in the activities that are based on transactions. Since the contract of investment in the equities market is fundamentally founded on the principle of profit and loss sharing, there is no Shariah issue on the contract of investment in the equity market. Purchasing a share in any stock exchange is lawful according to Islamic law since doing so constitutes a musharakah agreement between the shareholders. This contract, in and of itself, satisfies the requirements. On the other hand, concerns based on Shariah law mostly center on the business practices of the companies to which the invested capital (in the form of share subscriptions) is put to use. These activities may include the sale or purchase of assets and services that are not permitted by the principles of Shariah. For example, the sale or purchase of food and drink that is not halal would fall under this category of activity. Non-approved operations include everything relating to the balance sheet of the company, such as the borrowing of money or the raising of additional capital through interest-based transactions like overdrafts and conventional bonds. Other examples of activities that fall into this category are conventional bond offerings and overdrafts. When it comes to investing, which requires money to be put into actual economic activity, Islamic commercial law is also relevant to the transactional operations that corporations engage in. This demonstrates that compliance in Islamic finance is vital, both at the contractual and transactional levels. This is one of the characteristics that differentiates Islamic financing from conventional finance.
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Islamic FInance - Islamic financing in contrast to more traditional forms of finance
Because money cannot generate additional income on its own, direct dealings with money are not permitted in Islamic finance and should not be allowed either. To generate additional income, one must first invest money in legitimate company endeavors. This is the fundamental premise upon which trading is based. In other words, IFIs make it easier for consumers to obtain the financing they require by acting as sellers, lessors, or partners, depending on the specific circumstances. The function of money has shifted from that of a commodity into that of a facilitator, making it possible to engage in trade, leasing, and investment. The pool of money, which is collected from numerous Islamic accounts and/or funds contributed by shareholders, is channeled to finance activities involving either commerce, leasing, or investment. The money has been invested into real economic stock so that more income can be generated, seeing the situation from a microeconomic point of view. Dealing with a physical asset rather than a monetary asset is the reason why international financial institutions (IFIs) are able to turn a profit. A straightforward example of this would be the situation in which a financial institution lends a client the sum of 100,000 pounds to finance the acquisition of a property from a seller at the price of 100,000 pounds. The initial one hundred thousand pounds will be put toward the purchase of the residence in question by the bank from the seller. As a result of this action, a monetary asset has been converted into a real asset, specifically a house. The customer will eventually be able to purchase the exact same home from the bank. The purchase price, calculated using a Murabahah contract, is £120,000 and is spread out across ten years' worth of payments. The entire procedure represents a radical change from the traditional practice of lending and borrowing money. Before a customer may acquire a home using Murabahah finance, the bank that is providing the financing must first buy the home. There are actual sales and purchases that take place behind the scenes of this facility; hence, in some jurisdictions, this would result in a stamp duty being levied twice on the two different sets of paperwork. The applicable stamp duty legislation in those jurisdictions have been updated to reflect the essential revisions in order to prevent the payment of double stamp duty for these two transactions. Islamic Finance - A division of profits and losses
In addition to these two prohibited things, the concept of profit and loss sharing is closely associated with Islamic finance because of its close ties to Islamic economics. IFIs will share the profit or loss, depending on the circumstances, with depositors as well as fund users if the contracts entered into by the two parties are based on either Mudarabah or Musharakah. This is a novel practice that sets IFIs apart from other financial institutions. When it comes to deposits, IFIs take on the role of manager, while individual depositors take on the role of capital suppliers. Individual depositors supply their capital on the basis of a Mudarabah contract, and can do so through an investment or savings account. The profitability of the bank will be split among the depositors according to a predetermined ratio. Under the terms of the Mudarabah contract, the depositor is responsible for bearing the entirety of the loss, while the banks stand to lose their time, labor, effort, and anticipated profit. IFIs have the option of providing their consumers with financing through either Mudarabah or Musharakah. In this scenario, the IFIs play the role of the providers of the capital and divide the profit with their clientele once it has been realized in any business endeavor. Under the Mudarabah contract, the loss is the responsibility of the IFI; but, under the Musharakah contract, both the IFI and the customer are expected to contribute to the loss. Because of this distinction, Islamic finance can be differentiated from traditional finance. Islamic Finance - The Gharâr
Another thing that ought to be avoided in any transaction is something called gharar. Gharar is an Arabic word that means "ignorance" or "uncertainty," and it describes a situation in which there is a possibility that the outcome would be unfavorable to one side. This lack of information, in addition to a lack of control over the outcome of any transaction, could be the result of a misrepresentation, mistake, fraud, duress, or terms that are beyond the knowledge and control of one of the parties to the contract. There are many examples of Gharar-based transactions that are illegal, one of which is the sale of the offspring who are still developing inside the womb of a pregnant animal. This is due to the fact that the outcome is manifestly beyond the control of the parties involved and is therefore unknown. In addition, it is against the law to sell fish in the water, birds in the air, or a horse that has gotten away from its owner. This is due to the fact that it is questionable whether or not the vendor will be able to deliver the items in question. In practical terms, the term "gharar" refers to potential concerns over the pricing, delivery, quantity, and quality of assets. These are all transactionally-based concerns that could influence the degree to which the parties to a contract assent to certain terms. Because an option's underlying shares are not ascertainable and price, for instance, one cannot acquire an option at a specific price in order to obtain the right to purchase those shares. This is because an option is uncertain. A choice is the same thing as a right. It is not a valuable item whose requirements are understandable and within reach. Because both the premium that policyholders are required to pay and the indemnity that the insurer is required to pay out in the event of a claim are subject to the same level of uncertainty in conventional insurance, Islamic law does not recognize conventional insurance as valid. In contrast to Riba, whose value is established according to a predetermined formula that was just covered, the value of Gharar is established according to a number of different criteria. This is due to the fact that the parameters of knowledge or permission, as well as society's tolerance for risk, are not set in stone. First and foremost, Islamic business law has acknowledged the distinction between big uncertainty (Gharar Fahish), which must be avoided at all times, and minor uncertainty (Gharar Yasir), which is tolerated by society. Gharar Fahish is the term for significant uncertainty, and it is this type of doubt that must be avoided. The fact that people in some countries are expected to pay a set fee in order to make use of public restrooms is illustrative of the degree of tolerance that exists in those societies. The society is willing to settle for variable levels of utilization of utilities in exchange for a regular payment that is always the same amount. Islamic Finance - Riba
The Arabic word riba can be literally rendered in English as either usury or interest. Regardless of the amount that is paid back, any premium that is levied for money that is borrowed is considered to be riba. Riba can be defined in its most basic form as the gain of an advantage by one party at the expense of another party without any adequate consideration being given. The question of this unwarranted benefit is addressed by Islamic commercial law in the context of two possible transactions, namely a contract for a loan or cash exchange, as well as a contract for the trade of barter goods. There are two distinct groups of assets that can be subject to riba, and all Muslim jurists have come to the conclusion that these groups are currency or money, as well as a few commodities, primarily food products. The conditions for completing an exchange that involves either of these kinds of assets are exactly the same. According to the tradition, the Prophet Muhammad was reported to have said the following: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt, like for like, equal for equal, hand-to-hand, and if the commodities differ, then you may sell as you wish provided the exchange is hand-to-hand." These requirements are only relevant when there is a transaction involving the exchange of one currency for another currency, regardless of whether the currencies involved are the same or different. The standards also apply to the process of exchanging one food item for another food item, regardless of whether the new food item is of the same type or a different type entirely. When exchanging assets of the same class, you are required to hand over an amount of the counter value that is equivalent to the assets themselves. When one currency is exchanged for another currency or when one food item is traded for another food item, spot exchange, also known as the simultaneous delivery of counter values, is necessary. This is the case regardless of whether the currencies or food items being exchanged are of the same type or of a different type. In the event that the delivery is delayed in any way, the exchange will be considered to be equivalent to riba, also known as riba al-nasiah, which is simply riba because of the delay in the exchange or delivery of these two countervalues. When seen from a different angle, the transaction involving these two assets is similarly subject to the same amount or quantity of the two counter values provided that they are of the same kind. Should this requirement not be met, the practice of riba known as riba al-fadl, in which riba is determined by an excess of one of the counter values, could emerge as a result. However, if they are of different sorts, such as GBP for USD or wheat for barley, the requirement to have the same quantity does not apply because it is not relevant. This custom forms the basis for the permissibility of currency exchanges that are carried out on the basis of the current rate of exchange, such as exchanging one thousand pounds sterling for three thousand dollars, provided that the transaction is carried out on a spot basis. Because it is not in accordance with the needs of the tradition, any deferral of the exchange or delivery, such as in the case of a forward currency exchange, is forbidden. This is because it is not in line with the standards of the tradition. When exchanging two separate usurious products, such as USD for GBP, the quantity that is being exchanged is irrelevant. Because of this, the Riba theory may be summed up as follows: RIBA(1) is defined as the exchange of two similar usurious items for differing countervalues and/or for deferred exchange; for instance, the exchange of one another on a deferred basis of one thousand pounds for one thousand and two hundred pounds. RIBA(2) is the exchange of two different types of usurious goods for postponed exchange. One example of this would be exchanging one thousand pounds for one thousand dollars on deferred exchange. According to the information presented above, riba (also known as interest or usury) is applicable to situations in which a borrower is required to repay the main amount borrowed in addition to a premium in the same currency. This type of loan would be granted in British pounds by conventional banks and other institutions. Because the borrower is compelled to pay more than he borrowed and repayment will take place in the future, this practice of modern Riba in the banking sector is related to both Riba al-nasiah (Riba by postponement) and Riba al-fadl (Riba by excess). This is the reason why traditional savings accounts and fixed deposit accounts, in addition to all forms of financing that are based on loan-for-interest, do not comply with the principles of Shariah. The riba theory can also be used to the exchange of currency, which can take place exclusively in the spot market. It is not possible to engage in forward or future currency transactions. It is essential to provide an explanation for one exception to the aforementioned principles of exchange involving either monetary values or various types of food. A loan contract known as Qard or Hassan is permissible under Islamic commercial law; nevertheless, the interest charged on the loan cannot exceed the legal maximum, known as riba. However, Islamic commercial law "tolerates" the necessity of needing to exchange two countervalues on a spot basis because this demand is inconsistent to the notion and philosophy of a loan, which is fundamentally to enable the borrower to settle their loan obligation at some point in the future. It makes no sense to give them a loan if they have to repay it so quickly after taking it out, because then the loan is meaningless. This exception is given in order to make it possible for individuals to engage in the activity of lending fungible items or money without charging a fee. The prohibition of any excess in the repayment of the loan is far more pertinent to the discussion. If the borrower is in need of financial assistance in the form of money, then the lender may be willing to accept a delay in the repayment of the loan for a period of time. Therefore, the concept of riba could be summed up as follows: "The stipulation of an excess for the lender in loan is prohibited, and it amounts to riba, whether the excess is in terms of quality or quantity or whether the excess in a tangible thing or a benefit, and whether the excess is stipulated at the time of contract or while determining the period of delay for satisfaction or during the period of delay, and, furthermore, whether the stipulation is writing or is part of the customary practice. Islamic Finance - The fundamental tenets of Islamic legal precedent
Simply put, Islamic finance refers to any financial dealings that are in accordance with Sharia law. In addition to adhering to the characteristics described above, Islamic financial products and services are not allowed to include any principles, terms, or conditions that are in direct opposition to well-established legal maxims or legal principles. These legal maxims are the guiding principles and key dimensions of Islamic law, and the majority of Muslim jurists agree that they should be followed. A good illustration of this would be the idea that the management or any other partners in an equity-based financing or investment arrangement are not allowed to guarantee the money. To accurately convey the nature of equity investment—namely, that investors in equity must accept the possibility of experiencing a loss of capital—a contract for equity must not provide any form of capital guarantee. Islamic Finance - Products or services that are against the law
One more requirement that must be met for Islamic finance to be considered legitimate is that it cannot be used to facilitate the sale of products or services that are illegal. These forbidden goods and services include, among other things, foods that are not considered halal, such as pork, animals that have not been slaughtered or animals that have not been slaughtered in accordance with Islamic principles, alcoholic beverages, entertainment and pornography, tobacco-related products, and firearms. Non-participation is not only restricted to purchasing or selling but also encompasses all production and distribution chains, such as the packaging, transportation, warehousing, and marketing of these illegal goods and services. Non-participation is not limited to buying or selling but also includes all of these activities. Islamic Finance - Conformity to the Sharia
The observance of Sharia law lies at the heart of the Islamic financial system. IFIs, Islamic insurance companies, Islamic funds, and any other providers that offer Islamic financial products are required to establish a Shari'ah advisory or supervisory board in order to assure compliance with Islamic financial regulations. This is one of the distinguishing characteristics of Islamic finance. The establishment of an advisory board, the opinions of which are supposed to be followed by all IFIs, is necessary in order to direct the institutions toward conformity with Shariah law. It is impossible for a company or organization to legitimately assert that it engages in Islamic financial transactions until it establishes a Sharia board or committee that is comprised of qualified scholars who have a solid reputation and who are in possession of the essential skills. Islamic Finance - Rights and responsibilities of both banks and their clients
Not only are the rights and duties of banks and their clients thoroughly recorded in traditional banking laws, but also in the legislation of many nations, such as contracts acts, the sale of goods acts, consumer protection acts, and hire purchase acts. This is the case for both traditional banking laws and the legislation of many countries. The Islamic banking system brings a fresh viewpoint to this kind of connection, which is one of its most significant and fundamental characteristics. Because of this, Islamic banking has moved outside the realm of typical and traditional "banking business." An Islamic bank is neither a lender nor a borrower; rather, it can become a legitimate trader and get a license to do so under applicable banking law. Despite the fact that certain adjustments have been made to a variety of legal systems, this component of the transaction has not been given the appropriate attention it deserves until now. This element is illustrated by recent amendments to the stamp duty legislation and the real property gains tax in countries such as Malaysia, the United Kingdom, and Singapore, respectively. If this weren't the case, the purchasing and selling of real estate, for example, would be subject to a double stamp duty because there would have to be two transactions to satisfy the product's desired financing characteristics. The modifications eliminate the need for a capital gains tax to be paid on the profit made by the bank from the sale of the property to the customer, which is the second of two sales transactions. The acquisition of the asset by the financier from the vendor marks the beginning of the first transaction. The second transaction takes place when the financier sells the identical asset to their client at a higher price than they first paid. Both transactions would result in a loss if not for these essential adjustments that need to be made. In actuality, this expense or additional tax would have to be absorbed by the buyer, which would result in Islamic products having a higher price tag from the standpoint of the customer. Islamic Finance - A division of profits and losses
There is the potential for profit and loss sharing in certain activities including Islamic banking. Either on a proportional basis or according to a profit-sharing ratio that has been agreed upon, the bank will distribute the profit it makes to its customers. In the event of a loss, the loss will be carried by the bank in accordance with a Mudarabah contract, however in the event of a Musharakah contract, the loss will be shared proportionately by both parties. This approach stands in stark opposition to goods that are predicated on a fixed income. Once more, the idea of sharing profits and losses is one that is unique to Islamic banking, despite the fact that, legally speaking, Islamic banking is not an equity market in the traditional sense, which is generally represented by the stock market. |
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