Islamic Finance Concepts Quiz

Islamic Banking Principles

• Islamic banking, also known as Islamic finance, is finance or banking activities that adhere to Shariah (Islamic law).
• Two fundamental principles of Islamic banking are profit and loss sharing and the prohibition of interest.
• Islamic banks make profit through equity participation, requiring borrowers to share profits with the bank instead of paying interest.

Partnership Contracts (Musharakah)

• Musharakah is derived from the word sharaka, meaning sharing and mixing ownership.
• AAOIFI defines Musharakah as an agreement between parties to combine assets, labor, or liabilities for the purpose of profit.
• The Quran and Sunnah acknowledge partnership and guide partners on conduct.
• Musharakah can be categorized as Sharikah Al-Milk (holding ownership) or Sharikah Al-'Aqd (contractual partnership).
• Types of Musharakah include Shirkat (Partnership), Shirkat al-Milk (Holding Partnership), Shirkat al-Mudarabah (Trustee Partnership), Shirkat al-Amwal (Partnership in Capital).
• Other Musharakah types include Shirkat al-Mufawadah (equal shares), Shirkat al-Inan (unequal shares), Shirkat al-Uqud (contractual partnership), Shirkat al-Amal/Abdan (partnership in work), and Shirkat al-Wujuh (receivable partnership).
• In Sharikah al-milk, each partner is responsible for their share only and can't act on behalf of another without permission.

Partnership Contracts (Mudharabah)

• Mudharabah (Partnership) is derived from Al-darb fi al-Ard, meaning to travel.
• Mudharabah is a profit-sharing partnership, where one party (Rabbul mal) provides capital and the other (Mudarib) provides labor.
• Profit is shared based on a previously agreed ratio.
• Losses are solely borne by the capital provider.
• Mudharabah types include unrestricted and restricted contracts.
  • Unrestricted allows the Mudarib to conduct investment without restrictions.
  • Restricted imposes conditions on location, investment type, or other factors, but not severely limiting the Mudarib's operations.
• Mudharabah contracts are non-binding at the beginning but can be terminated with notice, and can be liquidated based on established conditions such as the set time limit, maturity, exhaustion of funds or losses, death of the Mudarib, or the liquidation or insanity of a party.

Security Contracts (Kafalah)

• Kafalah (guarantee) means guaranteeing oneself or another.
• Classical jurists defined Kafalah as a conjoining of the guarantor's liability to the guaranteed's liability.
• A third party becomes a surety for the debt.
• Kafalah includes Kafalah bi al-mal (guaranteed return of an asset), Kafalah bi al-nafs (guaranteed presentation to a specific authority), Kafalah bi al-dayn (guaranteed repayment of a loan), Kafalah bi al-ayn (guaranteed payment or delivery), and Kafalah bi al-da'rak (guaranteed freedom of an asset from encumbrances).

Security Contracts (Rahn)

• Rahn is an Arabic noun, meaning constancy, continuity, holding, and binding.
• Rahn, also known as pawning, mortgage, collateral, charge, lien, and pledge, utilizes a property as security to repay a debt.
• Conditions for Rahn include:
  • The debt/liability must be established, binding, and enforceable (loan, sale, damages).
  • The debt must be known and defined.
  • The debt must be matured or binding.
  • The pawned object should be in the creditors' possession.
  • Conditions for the pawned object's validity include debtor's permission, eligibility of the parties, and permanency of possession.

Agency Contracts (Wakalah)

• Wakalah is a contract in which one party delegates another to act on their behalf in a particular matter.
• The agent is authorized to conduct any dealings on the principal's behalf.
• The contract can be established through verbal or written consent, action, signs or via other means.
• The agent can be appointed immediately or at a later date.
• Both the principal and agent must be competent to enter the contract.
• The principal commissions the agency without coercion. The agent isn't forced to conduct tasks.
• The Wakalah objective must belong to the principal and be permissible by religious law.
• The objectives should not include prohibited activities or dishonest actions like theft or riba-based business.
• Contract objects cannot be from public property for example wood from public lands
• Types of Wakalah contracts include general or specific agency assignments, paid or unpaid commission, continuous or temporary assignment, and binding or non-binding agency contracts.

Islamic Financial Market Components

• Money Market: A segment for trading financial instruments with high liquidity and very short maturities (overnight to 12 months, typically 3 months or less) for wholesale short-term funds. Instruments include CDs, bankers acceptances, Treasury bills, commercial paper, federal funds, and repos.
• Capital Market: For long-term transactions with maturities longer than 12 months. Instruments include Sukuk, Bonds, and Equities. Trades are exchange-traded or OTC.
• Commodity Market: For trading commodities and precious metals, used by hedgers and traders.
• Derivative Markets: Trading financial instruments whose values are derived from underlying instruments (e.g., futures, swaps, options, and forward rate agreements). Settlements are conducted on a forward/future timeline in contrast to the spot basis of other markets.
• Foreign Exchange Market: For transactions in foreign currencies (spot and forward). Trades are OTC and in a variety of currencies (e.g., USD, GBP, EUR, SGD, JPY).

Islamic Money Market (IMM) Functions

• The major function of IMM is to facilitate the transfer of investable funds from surplus to deficit units to meet short and long-term liquidity needs.
• It also supports Islamic accepted Bills for importers and exporters for working capital financing.
• IMM helps with liquidity management, facilitating Islamic market instrument trading, and helps Central Bank conduct monetary policy.

Money Market Instruments

• Treasury Bills: Short-term government securities, representing national government debts, traded on a yield basis with no interest; sold at a discount maturing in 3, 6, and 12 months.
• Repurchase Agreements (Repos): Bilateral transactions for buying and reselling securities with an agreement for the investor to buy back at a fixed price at a fixed time. Used frequently in the money market.
• Negotiable Certificates of Deposit (CDs): Bank-issued securities documenting a deposit and specifying rate and maturity date. Used to enable deposits to trade in the secondary market.
• Commercial Papers: Short-term, unsecured (promissory notes) debts issued by corporations maturing in no more than 270 days. Typically issued by companies with good credit scores.
• Banker's Acceptances (BAs): Short-term, zero-coupon debt papers issued by companies, guaranteed by a bank. The bank guarantee improves credit rating and makes them transferable for secondary market trading.

Islamic Microfinance and Social Finance

• Islamic microfinance provides financial services to lower-income individuals or groups in accordance with Islamic law, focusing on helping small or expanding businesses.
• Transaction size is typically small, and services are provided by profit and non-profit organizations.
• Products include microcredit, micro savings, and micro-insurance.
• Islamic principles regarding prohibition of interest (riba) is a primary aspect of the business.
• Other principles in Islamic microfinance include risk-sharing, social development, and purity of contracts.

Islamic Microfinance Products

• Murabaha (Cost Plus Sale): A common method for financing where the bank purchases a good and sells it to a client with a profit margin agreed upfront, suitable for purchasing agricultural goods or equipment.
• Salam (Forward Sale): A contract where advance payment is made for goods to be delivered later. Ideal for agricultural financing.
• Istisna (Manufacturing Contract): Financing for projects where a good is to be manufactured before payment is made. Used for production and construction purposes.
• Ijara (Islamic Lease): Leasing of equipment by a client in exchange for a rental fee.
• Diminishing Musharakah/Musharakah & Mudarabah: Joint investment contracts where partners share profits and losses, suitable for various business ventures.

Concept of Social Finance

• Social finance refers to the economic activities of the third sector, aiming for social welfare of members, customers, or society, focusing on those who are underprivileged.
• It addresses social, economic, or environmental gaps not adequately addressed by the public or profit-oriented private sector.
• Social finance is an intermediary between traditional business, aimed at financial gain, and traditional charity, seeking social value.

Role of Economic Agents in Social Finance

• Bayt al-mal: The public treasury, historically used for social needs.
• Bayt al-zakah: The collection and distribution of Zakat, a mandatory practice in Islam, aimed at community economic well-being.
• Waqf institutions: Donations or endowments supporting social and economic needs.
• Non-governmental organizations (NGOs) and charitable organizations: Non-profit groups working in varied areas and taking varying roles.
• Private sector businesses: Businesses contributing to social impact in addition to financial goals.
• Banks: Banks implementing social finance.
• Microfinance institutions: Supporting low-income individuals and businesses to generate economic opportunity.
• Takaful and micro-takaful: Types of Islamic insurance programs.

Social Security

• Social security is a basic human need addressing the loss of income or financial stress related to unforeseen events such as illness, unemployment, disability, or death.
• It's a comprehensive program, addressing a range of human activities and societal situations.

Islamic Concept of Social Security

• Zakat: The first Islamic social security institution and a mandatory practice in Islam to provide for a distribution of wealth within the Muslim community.
• The State's role: The State’s role involves the collection of Zakat and managing funds in support of social needs.

Takaful

• Takaful operates on Tabarru (voluntary charity), differentiating it from conventional insurance, which operates on a bilateral contract.
• Operators are entitled to a fee for managing investments, though not sharing profts, in this method of Takaful.

Waqf model

• Waqf funds are established through donations or contributions with ownership rights lost upon contribution, used solely for the benefit of participants.

Test your knowledge on Islamic finance terminology with this quiz focused on key concepts such as 'Rahn' and 'Sharikah Al-Wujuh'. Discover the meanings, derivations, and contexts of these essential terms. Challenge yourself and deepen your understanding of Islamic financial partnerships.