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Questions and Answers
What type of financial transaction does Islam justify a return on capital for?
In Islamic finance, what is the role of an Islamic financial institution as a Mudarib?
What distinguishes the relationship between a conventional bank and its depositors from that of an Islamic bank and its 'investment depositors'?
What form does the Islamic bank's prospective income take in relation to the underlying transaction?
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Why does an Islamic deposit account have equity-like characteristics?
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What distinguishes debt-based contracts from equity-based contracts in Islamic finance?
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What is the primary way conventional banks generate profits?
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Which financial concept refers to the difference between the interest paid to depositors and the interest charged to borrowers?
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What is the purpose of Wa'd in Islamic financial services?
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In Islamic finance, what type of transaction involves an underlying asset or enterprise?
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Study Notes
Types of Contracts
- Islamic finance contracts can be divided into two main categories: debt-based and equity-based.
- Debt-based contracts result in a debt being repaid, such as Murabaha and Salam transactions.
- Equity-based contracts are based on an underlying asset or enterprise, such as Musharaka, Mudaraba, and Ijara.
- Other types of contracts include Wa'd (promise) or Arboon (down payment), which are not specifically based on debt or equity.
Islamic Financial Intermediation
- In conventional banking, the bank acts as a financial intermediary, accepting deposits from clients and granting loans to others at a higher interest rate.
- The bank generates profits from commissions and the 'spread' (difference between interest rates paid to depositors and interest charged to borrowers).
- In Islamic finance, the transformation of deposits into loans does not justify the spread, as it constitutes a pure return on money, which is prohibited (Riba).
- A return on capital is justified only when the capital has taken the form of a real (non-monetary) asset, Usufruct, or service.
- In Islamic finance, profits must be linked directly with economic activity, thus keeping debt under control and directing money capital to the most productive uses.
- The financial intermediary role of an Islamic financial institution includes identifying projects in which it can invest the customer's funds.
- The contract between the customers and the bank is a type of partnership (Mudaraba) contract, where the bank is the Mudarib (business manager) and its customers are the Rab al Mal (investors).
- The bank's prospective income is tied to the underlying transaction and takes the form of a share of the profit or loss rather than a spread.
- Islamic deposit accounts have equity-like characteristics, with investors' capital ultimately at risk, even if the bank remains solvent.
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Description
Explore the differences between debt-based contracts and equity-based contracts in Islamic finance. Learn about Murabaha, Salam transactions, and other types of contracts based on underlying assets or enterprises.
