Islamic Finance Resists Equity Shift, May Stunt Growth

Shariah finance has been labelled “copycat” for its reliance on debt funding

Reuters – KUALA LUMPUR, April 27 — When Kuwait Finance House Malaysia helped develop a US$1.3 billion (RM4.1 billion) real estate project in the country in 2005 as a partner in the deal, Islamic equity property ventures were a rarity.

Five years on, the bank is embarking on its fourth building project using a similar equity concept but few others in the industry want to follow the same path, reflecting Islamic finance’s slow and difficult shift away from debt instruments.

Debt funding’s dominance of Shariah finance has earned the US$1 trillion industry the tag of “copycat” and limited its growth as critics question its ability to offer a fairer way of sharing risks and rewards that truly distinguishes it from conventional banking.

“Profit-sharing or equity structures are the true way of doing Islamic financing,” said Siti Mariam Mohd Desa, Kuwait Finance Malaysia’s real estate advisory director.

“It is a different concept because if you were to give out straight loans, you may as well go to a conventional bank.”

As the global financial system emerges from the debt crisis and banks shy away from assuming added risks, practitioners want Islamic finance to rely more on partnership structures and less on straight financing which they say has created a brand of finance which is Shariah compliant in form, but not in spirit.

They say equity financing such as musharaka and mudaraba are closer to the Shariah’s aim of ensuring gains and losses are shared equitably and a shift back to it would help banks win new business beyond its traditional markets.

While Islamic finance has flourished in Muslim markets such as the Middle East and Malaysia, many non-Muslims are unconvinced, saying the industry differs from conventional banking only in name.

“We cannot add value in markets which are mimics of conventional markets. At the moment, it’s difficult to see the value-added,” said Safdar Alam, head of Islamic structuring at JP Morgan in Bahrain.

“It’s a real opportunity, with the increased awareness globally of Islamic finance, to demonstrate this value and the difference and benefits. This is a chance that we might miss if we don’t do this well quite quickly.”

But banks’ reluctance to bear the risk of projects funded, companies’ unwillingness to share profits and scarcity of banking capital make equity financing an unappealing proposition.

The recent property slump in the Gulf, where equity financing is more common, badly hit Islamic firms such as Bahrain’s Gulf Finance House and could compound banks’ fears of becoming project partners.

Kuwait Finance Malaysia, which uses the musharaka equity structure to develop real estate, had a non-performing financing level of 6.73 per cent in September, more than thrice the industry average.

Its parent Kuwait Finance House, the Gulf state’s top Islamic bank, posted a 24 per cent drop in net profit in 2009 to 118.74 million dinars.

Equity financing models were born out of a belief in Islam that the financier must share the risks if he wants the rewards and that profits should be earned through enterprise.

While equity funding is commonly associated with higher returns, bankers say it may not necessarily be more profitable than debt as the latter allows for higher leverage.

Traditionally, popular Islamic debt-based instruments such as istisna and murabaha have been likened to interest-based loans where banks take limited risks and are guaranteed a return.

But as Islamic finance grew beyond traditional roles such as agriculture financing to funding government budgets and billion dollar real estate projects, some banks began leaning more towards debt instruments to limit their risks.

As banks’ capital grows scarce, they will be wary of parting with large sums to back equity ventures, said Mohammad Faiz Azmi, PriceWaterhouseCoopers’s global Islamic finance leader.

“On the demand side, the issue are is there enough corporates who are essentially willing to give up the upside?” Faiz said, referring to profit-sharing structures.

“The reality is that the people that would want to have equity forms of financing are usually the ones that you want to avoid lending money to anyway.”

Some practitioners say the push for more Islamic equity financing is ill-conceived.

“From the shariah’s perspective, there is no such evidence to support (the view) that Islamic banks or whoever wants to do business should do profit-sharing more than debt-based,” said Shariah scholar Aznan Hasan, who advises Barclays Capital London and Malaysia’s stock exchange operator Bursa Malaysia.

“Whether it is debt or equity that suits you better, it depends on commercial and business decisions, not Shariah matters.” — Reuters

Mudharabah and Musharakah are NOT Debt Contracts. Get it?

A Shariah expert claims that Asset-based Sukuk Mudarabah and Musharakah will fall out of favour as it is hard to accommodate a ruling on repurchase pledges, indicating the market would be permanently affected by the decree.

According to Moody’s, the issuance of Musharakah and Mudarabah based Sukuk fell 83 percent and 68 percent respectively last year.

Bankers and lawyers have been seeking ways to structure Sukuks that comply with a 2008 ruling by AAOIFI which forbids “borrowers” in Sukuk Mudarabah and Musharakah from promising upfront to pay back their face value at maturity. This follows a rule that parties must share risks under these structures but the industry had been concerned it would make Islamic bonds less palatable to investors. But the market is trying to find ways to accommodate the prohibition. However, Shariah adviser Dr Mohd Daud Bakar said it would be tough to do so, "It's very difficult because it goes against the very essence of Mudarabah and Musharakah because you cannot guarantee the capital (or profits) in equity-based contracts." (Reuters)

Which is exactly my point. Mudarabah and Musharakah are equity-based contracts and therefore should not be treated as debt-based contracts. Why the industry continues to structure debt papers based on an equity structure baffles me.

A Sukuk is not a bond and a Sukuk is defined by the underlying contract that governs it.

After so many years of being exposed to Shariah based finance, I’m stumped that the so called Islamic bond fund managers (and the rest of the market really) still view Mudarabah and Musharakah Sukuks as debt instruments. Well, I’m telling them again – it’s NOT. Sukuk Mudarabah and Musharakah investors are not borrowers, they are partners who are supposed to understand and willing to assume risks associated with such investments.

The market should take the lead by re-identifying their investment needs and demand the appropriate structure. If they want to invest in fixed income instruments, look for Ijarah, Murabahah or Istisna based structures.

If they want to invest in Mudarabah and Musharakah Sukuks, they better make sure they are looking at them from the equity perspective.

The reason why we are facing this problem is because we (the market/industry) continue to apply Shariah based finance on the conventional platform. If a Mudarabah and/or Musharakah based Sukuk has identical features with a conventional bond, why bother having an Islamic finance industry? Since the underlying structure is identical, we might as well merge the two since there is no difference apart from the name and legal documentation.

The growth of the Sukuk market can only be achieved if the industry accepts Sukuk as a unique instrument instead of equating it to and treating it like a conventional bond.

Controversies / Issues in IBF

Bay Inah / Tawaruq
Is viewed by some observers and practitioners as a hilah (legal trick), as the objective of the transaction is to exchange of money in different quantities at different times.
The argument for legalising or forbidding Inah and Tawarruq is based on the intention (niyyah) of the parties, i.e. real vs. declared intention.

Bay Inah is a legal sale in the Shafie School, where the intention is not a significant element in determining the validity of the contract. This is the basis for the endorsement of Bay Inah by BNM’s and SC’s SAC.
Rayner (The Theory of Contract in Islamic Law, 1991) concludes that the Malikis and Hanafis give due effect to the real intention or niyyah of the parties, but that as regards illicit motives both schools are reluctant to make such an uncertain element as motive a dependent factor of a legal act. The Hanbali School however, always gives precedence to real intention over declared intention. According to him, the general tendency of Islamic law seems to be to give priority to the declared intention. However, in the Shafie School, this is not just a tendency but a doctrinal stance.

Debt - property or money?
The Malaysian (presumably based on the Shafie’s opinions) view is that debt is a property and hence can be traded freely. For example, a RM100 million debt can be exchanged for RM90 million in cash without any implications.

The middle eastern views debt as money and therefore can only be changed with money of equivalent value. The RM10 million difference in the above example is therefore riba.

Purchase undertaking in an Ijarah transaction - valuation issues?
A purchase undertaking is part of an Ijarah transaction for the sole purpose of returning the leased asset(s) back to the originator. The Purchase undertaking (PU) is present because it was never the intention of the originator to sell the assets in the first place. Another reason is to facilitate the redemption of the principal, similar to the mechanics of a conventional bond/loan which explains why the PU is undertaken at nominal value and not marked to the prevailing market values.

The issue with PU is not whether it is allowed by Shariah or not but it has more to do with the price transacted under the undertaking. If the price is based on the prevailing price at the time of executing the undertaking, I see no issues. It is about justice and fairness to the contracting parties. If the market price is below the PU exercise price, it would mean injustice to the purchaser and conversely, it would be unfair to the seller if the market price is more than the price transacted under the PU.

Purchase undertaking in a Musharakah/Mudharabah transaction – capital protection?
Like the PU in an Ijarah transaction, its presence in a Mudharabah/Musharakah transaction is to facilitate the principal redemption to mirror the mechanics of a conventional bond. A PU under this circumstance tantamount to guaranteeing capital. It is permissible for a third party to guarantee capital but it should be done on the basis of hibah (gift).

Tendering for Short Term Papers

In the Malaysian debt market, a short term bond is called a Commercial Paper (CP). A CP is either issued via a tender or private placement. In a tender, the CPs will be issued to the highest bidder(s) making the tender process a platform for investors to demand a rate of return that matches their risk appetite and/or investment objective. The basis for the bids is on the credit worthiness of the issuer. Once the CPs is issued to the winning bidders, the issuer is compelled to pay the promised returns to the investors.

Surprisingly, the same tender process applies to the Islamic CPs (ICP). I can understand if the ICPs are issued based on the Ijarah or Murabahah contract, there should not any problem with individually setting the rental or mark-up. The problem is when Musharakah and Mudharabah based CPs are subjected to the same procedure. I just cannot comprehend how an investor can demand, upfront, a fixed profit from a Musharakah/Mudharabah venture. It is totally against Shariah principles and contravenes the “profit and loss sharing” (PLS) model. Although the transaction documents clearly states that the returns are merely “expected” profits but in all likelihood, the projection will be met, 100% of the time.

What’s worse, the ICP is (usually) issued at a discount to nominal value and the issue price is calculated in accordance with the formula specified in Part III, Section 5 of the FAST Rules, the same formula used to calculate the discount for the conventional CPs.

Shariah based instruments and transactions may not be compatible with conventional platform all the time, it must un on its own unique platform.

So much for being in the forefront of Islamic finance.

Islamic Profit Rate Swap (IPRS)

IPRS is the Shariah compliant version of the conventional Interest Rate Swap (IRS). The IPRS/IRS is a risk management tool whereby an institution which is contracted to pay fixed profit rates may hedge its risks by swapping the fixed rate payment obligation for another party’s floating rate obligations. IRS refers to a generic rate swap in which one party pays a fixed rate while receiving a floating rate. As in the IRS, the notional principal in an IPRS transaction is never exchanged, only the difference is settled.

The IRS is a derivative product and the widely accepted market standard is the International Swap & Derivatives Association, (ISDA).

As usual, I want to be the party pooper. My question is; is IPRS a Shariah based solution or a conventional product made Shariah compliant?

Azrulnizam Abdul Aziz of Standard Chartered Bank Malaysia (now Saadiq) describes the Islamic Profit Rate Swap as follows (Islamic Finance news (IFN) Guide 2007):
The Islamic Profit Rate Swap (IPRS) was introduced to assist in the management of profit rate risks, thus enhancing cash flows. Profit rate swap is a mechanism structured to allow bilateral exchange of profit streams using two parallel and back-to-back Islamic marked-up sale transactions (Murabahah).
It comprises of three possible structures, namely the IPRS, Islamic Cross-Currency Swap (ICCS) and Islamic Forward Rate Agreement (IFRA). In IPRS, a series of Murabahah sale and purchases are conducted, allowing parties to swap or exchange profit rates from fixed to floating rate or vice versa.

Therefore, in theory, an Islamic Profit Rate Swap would operate in the following manner:

Party A purchases assets on Murabahah (fixed mark-up/profit) terms. They know the exact amount of profit due throughout the repayment tenure.
Party B enters into a Musharakah venture. They can estimate the returns but would not know exactly how much profit is made until the accounts are finalised.
An IPRS would entail Party A paying Party B a fixed, known amount of profit while Party B pays A an amount which is only known at the end of the financial year. The two profit amounts will not be identical; being identical defeats the whole purpose of the transaction!

A Murabahah or Istisna transaction has a fixed profit rate. Ijarah transaction can have a fixed lease rate while Musharakah and Mudharabah have variable profit rates, even loss rate!

If profits are made by the Musharakah (or Mudharabah) venture, the swap works fine(-ish). What if the venture suffers a loss? What is swapped?

An IPRS utilises the controversial Tawarruq structure. If the two parties are merely paying each other the (cash) amount of profits, utilising Tawarruq clearly shows an attempt to circumvent Shariah prohibition of exchanging unequal amount of money (which results in riba).

I would conclude that the IPRS is not a solution based on Shariah principles. An IRS is created with the primary objective of capitalising on the movements of interest rates. It is a tool to make (or save) money from the movements in the price of money (interest). It does not entail any productive economic activity. It is merely a transfer of money from one party to another.

How then does an Islamic financier hedge against movements in profit rates? Profit rates, unlike conventional interest rates are dependent on the underlying transaction. There is no one universal profit rate across the board. A Murabahah profit rate for a risky aerospace venture for example, would not be equal to the profit rate of an identical Murabahah transaction involving the government’s (less risky) purchase of educational equipment. Similarly, the Ijarah rate for a residential property is not the same as that of a CBD commercial property. For equity based contract like Mudharabah and Musharakah, profits cannot be guaranteed; returns depend on actual performance of the venture.

My stand remains – continuing to develop solutions that mimic the conventional system will not develop Shariah based finance.

Article review – “Is AAOIFI Ban on Musharaka Sukuk Justified?”

A not so comprehensive review on the above article which appeared in the May/June issue of the Islamic Banker.

The title itself is misleading – AAOIFI did not ban Sukuk Musharakah, it is banning the current model of Sukuk Musharakah which has the elements of purchase undertaking (PU) and guarantees.

The gist of this article is based on the views of one mazhab overriding the views of the other mazhabs.

Badlisyah (BAG) – arguments for the Malaysian market player from the Malaysian (Shafie) perspective.

P.10, Col 1, para 3, line 4 – contradiction, Musharakah is NOT a debt instrument. It should not be treated as such as it defeats the purpose of structuring a Sukuk based on the principles of Musharakah.

P.10, Col 1, para 3, lines 6 to 10 – the Malaysian investors, market, legal and regulatory framework unfortunately does not support the Musharakah model. It is still a debt based market with debt based regulatory framework.

My opinion on the PU – giving debt characteristics to an equity based instrument. This is to satisfy the demands of the investing public who wants an “Islamic” structure but also wants the features of a debt.

My opinion on AAOIFI’s announcement - it should not create a panic, there should be a consensus on the “effective” date as in anything issued prior to the announcement should be given an exemption from the ruling.

Permissibility of debt trading – it is true that differing mazhabs have differing views, this is where the industry needs a respected global body to lay down the law as to which mazhab prevails. Alternatively, allow the practices of all mazhabs and leave it to the market to decide whether they want to subscribe to a certain issuance or not. In this case, each Sukuk issuance has to come with an additional label – that of the approving mazhab.

True sale versus Beneficial sale – BAG argues that it is merely an accounting issue. He contends that a beneficial sale is as good as a true sale (despite the asset still remaining in the balance sheet of the seller). The purpose of a sale in an Islamic transaction is to give absolute rights of the asset to the buyer (i.e. Sukuk investors). My question is; does beneficial sale accord absolute rights to the buyer when challenged in court, given that the name on the title remains under that of the seller?

My opinion on the trading of banking stocks on the GCC stock markets - the reason why they are traded at a discount is due to the fact that stock valuation is done based on conventional norms. If stock valuation is done with Shariah considerations, it may yield different prices.

BAG uses the argument that the PU is merely a Wa’d (promise) which is not legally binding. If the PU is put to test and challenged in court, would the holder of the undertaking be compelled, by law, to honour the undertaking? If they are, then it is no longer a Wa’d but a legally binding contract instead.

Loan/top-up/liquidity arrangement in case of shortfall in profits – in equity based structures, are the managers allowed to do the same? BAG again argues that this arrangement is merely a Wa’d and therefore not legally binding. Again, will it stand if challenged in court?

A guarantee by a third (non-related) party is seen as an act of benevolence, it should not have any strings attached or payments charged.

The recurring argument of substance over form – different mazhabs have different opinions on the subject and all their opinions are valid from the Shariah perspective. Again, to overcome this obstacle, label a product based on the approving mazhab and let the market decide.

P.14, Col 1, para 6, last 2 lines – oxymoron, Musharakah is not a fixed income instrument.


My conclusions –

Musharakah = equity. Therefore, if we choose to structure a Sukuk based on the principles of Musharakah, we should also adhere to the principles that govern equity structures.

Shariah parameters are split between the 4 main mazhabs. Any stand or ruling must be accompanied by the basis, i.e. which mazhab it was based on. At the end of the day, it is for the market to decide which is best suited for their needs.

Project Finance

There are many definitions for project finance.

Finnerty (1996, p. 2) defines project finance as:
. . . the raising of funds to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project.

Nevitt and Fabozzi (2000, p. 1) define it as:
A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flow and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan.

The International Project Finance Association (IPFA) defines project finance as:
...the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project.

The above definitions mainly describe project finance from the debt perspective i.e. as a loan transaction.

Mechanics of a Shariah based project finance:

If a project is financed under the contract of Istisna, the project sponsor or initiator shall award the construction job to a contractor and the contractor will be paid according to the agreed terms, be it progressively, periodically or bullet payment at satisfactory completion etc. The price paid will include the contractor’s profit margin.

The project sponsor/initiator may raise the funding for the project via a Mudharabah or Musharakah arrangement whereby investors are invited to participate in the project. The returns from the Mudharabah or Musharakah venture cannot be predetermined and it shall be sourced from the cash flow or revenue of the project. It is therefore acceptable that no returns will be earned during the construction and pre-operating period. The project is owned by the Mudharabah or Musharakah investors/venture and upon completion; they may lease the asset for rental income or sell the asset for profit.

Ijarah Mausufah Fi Dhimmah is an arrangement whereby the financiers of a project are able to earn the lease rental during the construction period in the form of advanced lease. The setback of this arrangement is that should the project stall or fail, the owners will have to repay the Lessee(s) the advance lease paid.

There is always a completion risk in project financing. Should the project fail to be completed, the contractors should be paid what is due to them based on the work done. The Mudharabah or Musharakah investors will then share, according to their respective rights; the proceeds form the disposal of the project. The investors have no recourse to claim the full amount of their investment unless fraud or negligence on the part of the contractor or project manager is proven.

The main difference between Shariah based PF and conventional PF are;

(1) Ownership of assets (project)
Under conventional financing the project is held as collateral and the financers can claim from project sponsors for any shortfall in repayment.
Under Shariah financing, the asset/project is owned by the financiers and therefore they can only claim up to the value of the asset/project or the outstanding lease rental and nothing more.

(2) Returns from financing
Conventional financiers are repaid a fixed, predetermined payment over a specified period regardless of the profitability of the project. Any overdue payment will be charged a penalty and a default will force the asset to be forced-sold to recover the debt. Any shortfall will be met by the project sponsor.
Under Shariah financing, the investors are paid returns only when the project has positive cashflow. They can only claim for payment if fraud or negligence on the part of the contractor/project manager is proven.

(3) Risk
Conventional project financing places the construction, completion, market risks on the borrower and the bank (financier) only assumes the credit risk of the borrower.
Shariah financing distributes the risks amongst all the parties involved in the project. No one party can be insulated from the risk, unless fraud and negligence is proven.


Having being so used to earning predetermined returns with some recourse, banks would naturally be hesitant to finance projects the Shariah way. To overcome this, Shariah based project financing has to be marketed differently, highlighting the merits of risk-reward sharing and equitable distribution of income.

Concepts Used in Islamic Trade (and Banking)

Some of the common contracts and concepts used to facilitate trade the Islamic way. These contracts are also used in Islamic banking and finance to facilitate financing transactions.

• "Bai-al-Dayn" - Debt-trading.
• "Bai-Bithaman Ajil (BBA)" - Deferred payment sales. Where goods are sold on a deferred payment basis at a price which includes a profit agreed by both the buyer and seller.
• "Bai Inah" - A buy and sell contract between two parties where one party sells his asset to the other (price is marked up, payment is deferred) and subsequently buys it back at the cost price paid on the spot. This is often considered a hilah to facilitate the transfer of money under the pretext of trading.
• "Bai Salam" - A contract where payment is made spot while the goods are delivered at an agreed later date. A form of advance payment trade but the goods may not necessarily be in existence.
• "Hibah"Voluntary, unilateral gift.
• "Hiwalah" - Transfer of debt.
• "Ijarah" - Lease contract. A lessor (owner) leases out an asset or equipment to its client at an agreed rental fee and pre-determined lease period. The ownership of the leased asset remains in the hands of the lessor for the duration of the lease.
• "Ijarah Muntahiah Bittamlik" - Lease and subsequent purchase. Muntahiah Bittamlik describes the transfer of the title of the leased asset to the lessee at the end of the lease tenure.
• "Istisna" - A contract to manufacture according to given specifications. The payment terms can either be spot, deferred or in instalments.
• "Kafalah" - Guarantee or surety given by one party who agrees to discharge the liability of another party, as stipulated in the terms of the guarantee.
• "Mudharabah" - Profit sharing and loss absorbing agreement between two parties, one the capital provider (Rab-al-mal) and the other, the entrepreneur (mudahrib). The profit-sharing ratio is agreed upon upfront while losses are borne solely by the financier.
• "Murabahah" - Cost plus sale where goods are sold at a profit and the profit margin is known to the buyer.
• "Musawamah" - Bargaining sale where the seller need not disclose the cost"Musyarakah"Limited liability partnership. All partners share profits on a pre-agreed ratio but losses are shared on the basis of equity participation.
• "Qardhul Hassan" - Interest-free loan or benevolent loan without a specified repayment terms or tenure.
• "Rahn" - Collateral. Where a valuable asset is placed as collateral for a debt, he collateral may be disposed in the event of default.
• "Sarf" - Currency exchange, i.e. buying and selling of foreign currencies.
• “Tawarruq” - Used in “Commodity Murabahah” transactions where an agent is appointed by the bank to purchase certain goods (usually metals other than gold and silver) which are sold to the customer at cost price with payment made spot. The customer then appoints the bank to sell the goods to another agent at a marked up price but payment is deferred.
• "Ujr" - Commission or fee charged for services rendered.
• "Urbun" (Arboon) - Earnest money which forms part payment of the price of goods or services paid in advance.
• "Wadiah Yad Dhamanah" - Savings with guarantee. It refers to a contract between the owner of the funds (depositor) and the Bank for safe-keeping purposes and the bank, as trustee, guarantees the repayment of the whole amount of deposits, or any part thereof, upon request.
• "Wakalah" - Agency contract. It refers to the appointment of an agent who is authorised to act according to the term of the agency.

Islamic Finance - a Primer

Islamic finance, as the name implies, is finance based on Islamic laws and norms and is a subset of Islamic economics. The principles of Islamic economics are sourced from the two main sources of Shariah, the Quran and Hadith (sayings of the Prophet pbuh). Contrary to Adam Smith’s theory of self interest, Islamic economics subscribes to the policy of ‘prosper thy neighbour’.

The Western model of finance is based solely on monetary transaction where the bank acts as the middleman between those with excess funds (depositors) and those in need of funds (borrowers). The structure of Western banking is that of a lender-borrower, exchanging money for money. The price of money is interest rates and the determinant of the price is the risk associated with ability of the borrower to repay. The utilisation of the proceeds is of no concern of the bank, only the timely repayments of the loan. Hence, the success of the business does not matter to the bank for as long as loan repayments are met by the borrower. The bank does not assume any risks associated with the utilisation of the funds, even if the economy turns into a recession, the borrowers are still contracted to repay the principal and interest back to the bank within the stipulated period. Failing this will result in further monetary penalty, compounded over time.

Islamic and Western (conventional) finance is akin to Petrol and Diesel engines; they run on totally different platforms. Using the wrong fuel would be very detrimental to the engines. Therefore, how it is conducted; the mechanics and modus operandi, pricing, risk management, repayment, recourse, transaction documentation and marketing and sales must conform to the basic Islamic principle of just and equity.

The most significant difference is the basic concept of Islamic finance – risk sharing partnership instead of a borrower-lender relationship. What this means is that all transacting parties must enjoy equal benefits from the transaction and in a case of a loss, all must share the loss equally. The transactions must be conducted in such a way that none of the parties have an unfair advantage over the others.

Being just and equitable does not mean at the expense of profits. Islamic law requires debts to be paid, contracts to be honoured and promises to be kept. However, there is also a need to be compassionate, when the debtor is facing financial distress, it would be the duty of the creditor to understand and not make matters worse. An alternative arrangement must be made to ensure the debt is repaid. Loans per se are not an Islamic financial instrument. Borrowing and lending money is not encouraged unless in times of distress. Debts or obligations to pay only arise in trade transactions where the payment terms are deferred. The only type of loan recognised under Islamic law is the “benevolent loan” or qardhul hasan. This loan does not carry any interest rate nor does it carry a fixed repayment period. The debtor is expected to repay as soon as he is able and the creditor is not encouraged to demand repayment. The elements of trust and responsibility play a fundamental role in this transaction.

Money according to Islamic law is not a commodity. They are merely the intermediary to facilitate a transaction and therefore on its own cannot be traded.

The main characteristics of Islamic finance include;

• Prohibition of interest (riba / usury).
• Prohibition of elements of gambling and uncertainty.
• Partnership instead of lender-borrower relationship.
• Full transparency and disclosure
• Transaction must not involve prohibited goods and services such as pork, alcohol, gaming, armaments.
• Profit and loss sharing instead of fixed returns on the part of financiers.
• Shariah compliant asset backed financing.
• No short selling, i.e. full ownership must be obtained prior to selling.

Islamic finance can be used to facilitate any kind of financial transactions such as;

• Project financing
• Working capital financing
• Leasing
• Trade financing
• Liquidity management
• Sukuk (investment certificates)
• Takaful (insurance)
• Mortgages
• Asset management
• Hire purchase
  

Common contracts / concepts used in Islamic finance include:

• Murabahah (cost plus sales)
• Ijarah (leasing)
• Musharakah (joint venture)
• Mudharabah (trustee profit sharing)
• Istisna (project financing)
• Salam (forward sales)
• Wadiah (trustee safekeeping)
• Wakalah (agency)
• Kafalah (guarantee)
• Hibah (gift)
• Ibra (rebate)
• Qardul Hassan (benevolent loan)
• Tawidh (penalty)
• Ujr (fee)
• Wad (promise)
• Rahnu (collateral)