Chapter 14 sources of finance - Islam

Question 1

how is it different in Islamic finance ?

Answer 1

Under the principals of Islamic law, wealth must be generated from legitimate trade and asset based investment.

Also investments must have a social and ethical benefit.

Speculative investments are not allowed and investments in such areas as alcohol and gambling are forbidden

Question 2

what is Riba ?

Answer 2

As a consequence of the laws regarding the generation of wealth, it is strictly forbidden to use money for the purpose of making money. I.e it is forbidden to charge interest (RIBA)

Financial institutions can not charge interest but instead provide services for a free or enter into a form of agreement which the client in which the risk and the profit / losses are shared between the institution and the client

Question 3

What are the Islamic financial instruments ?

Answer 3

Murabaha - this is effectively a form of credit sale. However instead of charging interest a fixed price is agreed before delivery

Ijara - this is effectively a lease.

Muduraba - this is similar to equity finance or a special kind of partnership where profits are shared and losses are attributed to the investor (limited to the capital provided)

Musharaka - similar to the partnership above, but here both parties provide capital and expertises. It is similar to venture capital

Sukuk - this is the equivalent to debt finance (Islamic bonds). Sukuk must have a tangible asset and Sukuk certificates own a proportion of the asset. For example a property that is bought and rented out and the holders receive a share of the rent (instead of interest)

The Sukuk manager is responsible for managing the asset on behalf of the holders.