Question

1. Title of the essay: How is Conventional Finance Differs from Islamic Finance.

It is a group essay consisting of 4 students in a group.

Word length of the essay: Maximum 2000 words

2. Please do brainstorm briefly with your group members for supporting ideas, an approach for the introduction, and  organization of the paragraphs. Clustering, and a brief outline can help your writing.

3. Make sure the introduction has a clear thesis statement, located at the end of the first

paragraph, to give the essay focus and direction.

4. Organize body paragraphs logically. Make sure each paragraph is closely related to

the topic and discusses one major point or group of related points. Each body

paragraph should have a topic sentence and sufficient supports related to it. The

sentences in any paragraph should follow an orderly, logical sequence. Also, be sure that

paragraphs do not overlap in content but have smooth transitions from one to the other.

5. Make sure the conclusion relates to the original thesis statement in a logical way. Avoid

introducing new or off-topic ideas.

6. Give a reference section means which books/ papers your are refereeing in support of your essay

Answer 1

INTRODUCTION

Islam is more than a religion; it’s also a code of life that deals with social, economic, and political matters. Every Muslim is expected to live according to the Islamic code, or sharia. Each issue addressed by sharia is entwined with all other issues; therefore, economic matters are related to religion, culture, ethics, and politics.

Islamic finance, then, is a financial system that operates according to sharia. Just like conventional financial systems, Islamic finance features banks, capital markets, fund managers, investment firms, and insurance companies. However, these entities are governed both by Islamic laws and by the finance industry rules and regulations that apply to their conventional counterparts.

CONTENT

A key purpose for imposing these laws and ethics is to promote social justice; Islam and social justice are inseparable, and it’s a key concept of the Islamic finance industry. Islam tries to achieve social justice in the economy in many ways:

• Promoting adherence to Islam: A Muslim is expected to adhere to certain core beliefs and perform certain obligatory acts. By reminding Muslims of their obligations, Islam seeks to promote stronger relationships between each person and Allah, between people and the earth, and among individuals.

• Requiring zakat: To promote justice related to the distribution of wealth, Islam imposes a property tax called zakat. Every Muslim who meets certain criteria regarding the accumulation of wealth must pay zakat, which is distributed to people in need. By taxing the property of people who acquire wealth and distributing that tax to people in need, Islam promotes the socially responsible distribution of wealth.

• Prohibiting usury (interest): For the sake of social justice, Islam prohibits interest-based transactions. No individual or business entity should hoard money in order to earn interest (or riba); instead, that money should be used to support productive economic activities.

• Encouraging shared risk: Islam encourages risk-sharing in economic transactions. When a risk is shared among two or more parties, the burden of the risk faced by each party is reduced.

• Avoiding gambling: Two Arabic words refer to transactions that involve gambling:

  • Maysir: The acquisition of wealth by chance and not by effort

  • Qimar: In modern gambling, any game of chance.

  Both types of transactions are prohibited because they’re based on uncertainty (gharar).

  The Islamic prohibition against transactions that involve gambling prevents Muslims from purchasing conventional insurance products because those products are a gamble. Instead, Islamic insurance, called takaful, is based on a very different model of risk management that involves shared risk and mutual responsibility.

Key Sharia Principles and Prohibitions in Islamic Finance which are not there in conventional finance

• Allah (God) is the owner of all wealth. Humans are merely the trustees of wealth, which belongs to Allah. Humans must manage wealth according to Allah’s commands, which promote justice and prohibit certain activities, including wasting or destroying resources. Muslims have the right to enjoy whatever wealth they acquire and spend in sharia-compliant ways.

• Material pursuits must be balanced with an individual’s spiritual needs. A Muslim’s economic activities and pursuit of wealth should balance with the spiritual aspects of life. Economic activity conducted according to sharia is, itself, an act of worship, but finding balance between economic activities and spirituality is key. A Muslim is expected to seek moderation in the material world — to avoid being either miserly or too materialistic.

• An individual’s needs must be balanced with society’s needs. A Muslim needs to consider society in general when enjoying Allah’s bounties. These considerations include promoting justice in all economic activities, remembering that all people have mutual responsibility for all others, and using the earth’s resources wisely.

• Economic transactions should take place within a just, responsible, free-market economy. Islam does not restrict economic activity but instead directs it toward being responsible to other people, to the earth, and to Allah. Islam allows for a free-market economy where supply and demand are decided in the market, but it directs the function of the market mechanism by imposing specific laws and ethics. A primary purpose for imposing these laws and ethics is to promote social justice: a balance in which wealth is not accumulated only by a few while most others suffer.

In support of these principles, sharia prohibits business transactions based on the following:

• Interest: Riba, the Arabic word for interest, means to increase, grow, or multiply into more than what would be due. Riba is prohibited by Islam because it creates societal injustice; in a riba-based transaction, the owner of the wealth gets return without making any effort, and the borrower carries all the risk.

• Uncertainty: The Arabic word gharar means uncertainty or to cheat or delude. Transactions based on gharar are unclear or ambiguous; not everyone involved knows what to expect and can make an informed decision. Gharar exists when two parties enter a contract and one party lacks complete information or when both parties lack control over the underlying transaction.

• Gambling: Two Arabic words — maysir and qimar — refer to transactions that involve gambling. Maysir is the acquisition of wealth by chance instead of by effort. Qimar refers to a game of chance. Both types of transactions are based on uncertainty; no one can know how a gamble will pay off.

• Prohibited products and industries: Islam prohibits products and industries that it considers harmful to society and a threat to social responsibility. Examples include alcohol, pork, prostitution, pornography, tobacco, and any products based on uncertainty or gambling.

• Contracts of partnership allow two or more parties to develop wealth by sharing both risk and return:

  • Mudaraba: One party gives money to another party, which invests it in a business or economic activity. Both parties share any profit made from the investment (based on a pre-agreed ratio), but only the investor loses money if the investment flops. The fund manager loses the value of the time and effort it dedicated to the investment. (However, the fund manager assumes financial responsibility if the loss results from its negligence.)

  • Musharaka: This contract creates a joint venture in which both parties provide investment capital, entrepreneurial skills, and labor; both share the profit and/or loss of the activity.

• Contracts of exchange are sales contracts that allow for the transfer of a commodity for another commodity, the transfer of a commodity for money, or the transfer of money for money:

  • Murabaha: In this cost plus contract, an Islamic financial institution sells a commodity to a buyer for its cost plus the profit margin, and both parties know the cost and the profit in advance. The buyer makes deferred payments.

  • Salam: In this forward contract, the buyer (or an Islamic financial institution on behalf of the buyer) pays for goods in full in advance, and the goods are delivered in the future.

  • Istisna: This second type of forward sale contract allows an Islamic financial institution to buy a project (on behalf of the buyer) that is under construction and will be completed and delivered on a future date.

• Contracts of safety and security are often used by Islamic banks; these contracts help individual and business customers keep their funds safe:

  • Wadia: A property owner gives property to another party for the purpose of safeguarding. In Islamic banks, current (checking) accounts and savings accounts are based on the wadia contract.

  • Hiwala: Debt is transferred from one debtor to another. After the debt is transferred to the second debtor, the first debtor is free from her obligation. This contract is used by Islamic financial institutions to remit money between people.

  • Kafala: A third party accepts an existing obligation and becomes responsible for fulfilling someone’s liability. In conventional finance, this situation is called surety or guaranty.

  • Rahn: A property is pledged against an obligation. A customer can offer collateral or a pledge via a rahn contract in order to secure a financial liability.

CONCLUSION

The main difference between Islamic and conventional finance is the treatment of risk, and how risk is shared.

The two main forms of Islamic finance are bank finance and issuing Islamic securities (called sukuk).

In conventional terminology you might think of these as debt – bank loans and bond issues respectively, but that is inaccurate. Those categories cannot be applied to pure Islamic finance.

In Islamic finance interest is prohibited. If an enterprise is financed by debt with an obligation to pay interest, the risk of the business is not being shared fairly.

Instead, Islamic finance requires that finance is provided on the principle of profit and loss sharing. Under shariah law finance can be provided through several types of contract. Each type specifies how risk is shared between the enterprise and the supplier of finance.

REFRENCES-

wikipedia

investopedia

corporatefinanceinstitute

dummies

islamic-banking