Chapter 1: Islamic Finance

Question 1

What is Islamic finance governed by?

Answer 1

Sharia law

Question 2

In which countries has Sharia law been adopted explicitly as part of the country’s legal system?

Answer 2

Pakistan and Iran

Question 3

What is usury?

Answer 3

Islamic finance is based on the belief that money shouldn’t have any value in itself.
It’s just a way to exchange things that do have a value. Connected to this is the belief
that you shouldn’t make money from money which means avoiding paying or
receiving interest.

Question 4

How do we avoid usury?

Answer 4

Although the charging or receiving of interest is not allowed under Sharia law,
generating and sharing profits is allowed and therefore it is necessary to structure
contracts along profit sharing lines.

Question 5

How are saving accounts structured to avoid usury?

Answer 5

With traditional savings accounts a customer transfers money (i.e. lends) to the bank
(the borrower) and they receive interest on the amount deposited in return.

Under Islamic finance, the contract is structured so that the customer is an investor,
and the bank is a fund or asset manager rather than a borrower. At the end of the
investment period, the customer’s money is returned with the profit earned, less a
management fee payable to the bank.

Question 6

How are loans structured to avoid usury?

Answer 6

Traditionally the bank transfers money to the customer so that the customer can buy
an asset, and over a set time in instalments the customer repays the bank the capital
loaned to them plus an interest payment.

Under Islamic finance this would be structured so that the bank purchases the asset
on behalf of the customer and then sells the asset at a profit to the customer. The
customer pays the bank in instalments, and the bank owns the asset until the final
payment has been made.