In: Finance
The Islamic financial system has evolved into a viable and
vibrant component of the overall
financial system, complementing the conventional financial system.
The system
encompasses the Islamic banking system, Islamic money market,
Islamic insurance or
takaful, Islamic capital market and the specialized financial
institutions which provide
alternative sources of financing.
Evaluate the requisite for a successful Islamic financial
system.
(400 Words)
Islamic finance may be viewed as a form of ethical investing, or ethical lending, except that no loans are possible unless they are interest-free. The objectives (maqsid) of Islamic finance transactions may be summarised as below:
Fundamental principles of Islamic finance
Prohibition of interest
The prohibition of interest is founded on the prohibition of riba, a term literally meaning “an excess” and interpreted as “any unjustifiable increase of capital whether in loans or sales”; this is the central tenet in mutual dealings.
Risk sharing
Because interest is prohibited, suppliers of funds become investors instead of creditors. The provider of financial capital and the entrepreneur share business risks in return for shares of the profits.
Prohibition of speculative behaviour
Islamic finance prohibits transactions featuring speculation including extreme uncertainties, gambling, and risks. Therefore, transactions in Islamic finance should be backed by real assets.
Sanctity of contracts
Islam teachings upholds contractual obligation's and the disclosure of information as a sacred duty. This feature is intended to reduce the risk of symmetric information and moral hazard.
Shari’ah-approved activities
Only those business activities that do not violate the rules of Shari’ah qualify for investment. For example, any investment in businesses dealing with alcohol, gambling, and casinos would be prohibited. Project finance, which puts emphasis on equity participation in transactions involving real assets, is natural fit for Islamic finance.
Microfinance
Microfinance is another candidate for the application of Islamic finance. Islamic finance promotes entrepreneurship and risk sharing, and its expansion to the poor could be an effective development tool, particularly for economic development of marginalised communities as well as poverty alleviation. The social benefits are obvious, since the poor currently are often exploited by lenders charging usurious rates.