ENMF 0244 Chapter 10: Islamic vs Conventional Finance PDF

ENMF 0244 FINANCE CHAPTER 10 ISLAMIC FINANCE VS CONVENTIONAL FINANCE  Learning Outcome Recognise Summarize the objective of Islamic Source of law for Islamic Contract of Islamic key compone...

ENMF 0244 FINANCE CHAPTER 10 ISLAMIC FINANCE VS CONVENTIONAL FINANCE  Learning Outcome Recognise Summarize the objective of Islamic Source of law for Islamic Contract of Islamic key components of Islamic finance and conventional finance and conventional finance and financial markets and finance. finance. conventional finance. conventional financial markets.  TABLE OF CONTENTS 01. 02. 03. 04. OBJECTIVE SOURCES OF PRINCIPLES VARIOUS of Islamic finance vs LAW GOVERNING CONTRACTS conventional finance. of Islamic finance vs Islamic finance vs Islamic finance vs conventional finance. conventional finance. conventional finance. 05. KEY COMPONENTS Islamic financial markets vs conventional financial markets.  OBJECTIVES Islamic Finance Conventional Finance Achieving Maqasid Shariah Profit maximisation to protect the right of people Any actions allowed as long as it Gain success in this world, and also brings profit to the company to achieve success in the hereafter and follow the country law. No principle of profit and loss Promotes profit and loss sharing sharing practiced. Functions limited principle between the financial to deposit collection, interest provider (bank) and customer payment, loans with interest, and (Mudharabah, Musyarakah) interest-based investment.  SOURCE OF LAW Islamic Finance Conventional Finance Revealed sources:Al-Quran, Do not rely on any Hadith, Sunnah, Ijma, Qiyas revealed sources and Ijtihad. Governed by human made law - to Also tied by the human made law safeguard the interest of financial institutions Example of regulation : Islamic Financial Services Act 2013 Example of regulation : (IFSA 2013) Financial Services Act 2013 Development Financial Institutions Insurance Act 1996 Act 2002 (Act 168) Hire-Purchase Act 1967, and others Shariah Governance Policy Document (SGPD) and others  ISLAMIC FINANCE PRIMARY SOURCE Source Definitilon Example Al Quran The book of revelation given to the Prophet Muhammad saw Al-Maidah:1 Habitual practice and behaviour of Prophet Muhammad saw during his Hadith lifetime Al Tirmidhi:1078 Agreement of the mujtahid as a whole on religious matters and issues that Ijma on permissiblity of Istisna and Salam Ijma' happens in certain times which is based on Hadith the Prophet. The use of deduction by analogy to provide an opinion on a case not referred Prohibition of other activities after last call of Friday prayer. Original case is the Qiyas to in the Al-Quran or the Hadith/Sunnah in comparison with another case prohibition of buying & selling activities. referred to in the Al-Quran and the Hadith/Sunna (Al-Jumuah:9) Ijtihad on Riba element in transaction Mujtahid reasoning relating to the applicability of certain Shariah rules on whereby they came out with alternatives Ijtihad cases not mentioned in either the Al-Quran or the Hadith/Sunnah. contracts such as Bay Bithaman Ajil, Ijarah, Murabahah, and others.  PRINCIPLES GOVERNING ISLAMIC FINANCE CONVENTIONAL FINANCE 01 Principles of Equity 01 Paying or charging an interest 02 Principles of Participation 02 Investing in businesses involved in prohibited activities 03 Principles of Ownership 03 Speculation (maysir) 04 Uncertainty (gharar) PRINCIPLES GOVERNING ISLAMIC FINANCE Principles of Equity Rationale for the prohibition of Riba with a view to protect the weaker contracting party in a financial transaction. Basis for prohibiting excessive uncertainty (gharar) as manifested by contract ambiguity. Transacting parties have a moral duty to disclose information before engaging in a contract, thereby reducing information asymmetry. Basis of a 2.5 percent levy on Zakat. PRINCIPLES GOVERNING ISLAMIC FINANCE Principles of Participation “Reward (that is, profit) comes with risk taking,” investment return has to be earned in tandem with risk-taking, and not with the mere passage of time, Return on capital is legitimized by risk-taking and determined ex post based on asset performance or project productivity, thereby ensuring a link between financing activities and real activities. The principle of participation lies at the heart of Islamic finance, ensuring that increases in wealth accrue from productive activities. PRINCIPLES GOVERNING ISLAMIC FINANCE Principles of Ownership Islamic finance adheres to a fundamental principle: "You must own an asset to sell it." This approach ensures that all transactions are rooted in tangible assets, forging a strong connection between finance and the physical world. Islamic finance places great emphasis on the preservation of property rights and the sanctity of contracts, making every deal a robust and trustworthy commitment. Principles Governing Conventional Finance Investing in business Paying or charging an interest with prohibited activities There is no restriction to Conventional banks may invest their conventional banks to charge any rate of money to any investment platform interest to maximize their profit regardless Haram or Halal platform (Shariah non-compliant activities). Uncertainty ( Gharar) Speculation (maysir) Conventional banks may impose any uncertainties aspects in their products or Conventional banks may involve with any contracts as long as it does not challenge speculation activities or gambling. the legislation.  ISLAMIC FINANCE CONTRACT There are various contracts adopted in the Islamic finance based on the product purposes VARIOUS CONTRACTS CONVENTIONAL FINANCE CONTRACT There is no variety of contracts adopted by the conventional finance.  COMPARISON OF ISLAMIC & CONVENTIONAL CONTRACT Products Islamic Finance Contract Conventional Finance Contract Wadiah (safe keeping) Deposit Qard (principle-based loan) (Saving & current) Tawarruq (commodity sale) Interest-based deposit Deposit (Fixed deposit) Mudharabaha, Tawarruq Personal Financing – Tawarruq Home Financing – Tawarruq, Musharakah Mutanaqisah Interest-based loan Financing Vehicle Financing – Al-Ijarah Thumma Al-bay Hire-purchase (vehicle financing) (Rental and sale contract) Mudharabah (profit sharing) Derivative Investment Tawarruq KEY COMPONENTS IN FINANCIAL MARKETS BANK CAPITAL MARKETS RISK PROTECTION Bank play roles as an Financial market where The other component of intermediary that connect long-term debt or equity- financial system is risk surplus and deficit units in backed securities are protection/management the economic bought and sold. through conventional system. insurance and Takaful. ISLAMIC BANKING VS ISLAMIC CAPITAL MARKETS VS TAKAFUL VS INSURANCE CONVENTIONAL BANKING CONVENTIONAL CAPITAL MARKETS  ISLAMIC BANKING VS CONVENTIONAL BANKING Islamic Banking Conventional Banking Is based on Shariah Law Is based on fully man-made principles. Profits are shared between the bank and depositors according to pre- Depositors are guaranteed predetermined rate of return. determined ratio and these profits are not guaranteed. It also aims at maximizing profit but subject to Shariah and legislative It aims at maximizing profit with only legislative restrictions. restrictions. Participates in partnerships and joint ventures with customers. Lend money with a predetermined rate of return. Relationship of an Islamic bank with its customers is that of partners, Relationship of the bank with customers is that creditors and debtors. investors, entrepreneurs, buyer, and seller. Islamic banking tends to create link with the real sectors of the economics Conventional banks use money as a commodity which leads to inflation. system by using trade related activities. Money is not a commodity though it is used as a medium of exchange and Money is a commodity besides medium of exchange and store of value. store of value. Therefore, it cannot be sold at a price higher than its face value. Therefore, it can be sold at a price higher than its face value. Profit on trade of goods or charging on services is the basis for earning profit. Time value is the basis for charging interest on capital It operates on profit-loss sharing basis. Interest is charged even in case the customer loss. No profit-loss sharing.  TAKAFUL VS INSURANCE Islamic Insurance (Takaful) Conventional Insurance An insurance contract based on sale A scheme of risk protection based on donation contract between insurance company and contract (Tabarru’) between Takaful participants policyholders Based on spirit of mutual protection and Based on spirit of self-protection assistance among Takaful participants Free from elements of Riba (interest), Gharar Practices elements of Riba, Gharar, and (uncertainty), Maysir (gambling) Maysir Insurance company is an insurer that Takaful operator is a trustee and fund manager protect risk Business operation and investment must comply Business operation and investment with the Shariah (Islamic Law) doesn’t need to comply with the Shariah There is separate ownership between company Single ownership (shareholder fund = risk (shareholder fund) and risk fund fund)  ISLAMIC CAPITAL MARKET VS CONVENTIONAL CAPITAL MARKET Islamic Capital Market Conventional Capital Market All products and services must comply with All products and services are allowed the Shariah Islamic banks provide equity capital to a Venture capital companies and project or venture. Loses are shared on the investment banks will take equity stakes basis of equity participation while profits are and management control of an enterprise shared based on pre-agreed ration for providing start up finance Restrict stocks of company dealing with Except for money laundering and the unlawful activities such as pork, alcohol, financing of criminal activities, other tobacco, and others activities are allowed Products: Sukuk, Shariah equities, Islamic Products: Bonds, Equities, Reits, Stock Reits