A Simple Introduction to Islamic Finance

A Simple Introduction to Islamic Finance

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A while ago Amuslima wrote about the difference of conventional and Islamic banksA Simple Introduction to Islamic Finance arrow. In this post, I tried to go back one step about the basic of Islamic Finance. Why do we have to deal with Islamic finance? Of course, because we are Muslims, replied many people. Actually, it is more than that. As Islam is a religion which also requires our logic to work, let’s see the basic why we must apply Islamic finance in daily commercial dealings.

Islam is a complete religion dealing with not only religious rituals; but it is also a way of life which regulates almost all kind of aspects in our life as Muslim. One of them is the economicA Simple Introduction to Islamic Finance arrow aspect. The foundation of commerce in Islam is very simple. It forbids usury and allows Muamalah or tradingA Simple Introduction to Islamic Finance arrow as mentioned in Surah Al Baqarah 275:

Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: “Trade is like usury,” but God hath permitted trade and forbidden usury. Those who after receivingA Simple Introduction to Islamic Finance arrow direction from their Lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (The offence) are companions of the Fire: They will abide therein (for ever).

Further, in trading, there are fundamental principles of commerce derived from Surah Al Hud 85-86:

And O my people! give just measure and weight, nor withhold from the people the things that are their due: commit not evil in the land with intent to do mischief. That which is left you by God is best for you, if ye (but) believed! but I am not set over you to keep watch!”

So, whenever we are the seller or the buyer, the above fundamentals must be remembered.

Therefore, talking about Muamalah itself requires its own booksA Simple Introduction to Islamic Finance arrow as it is a very vast subject. However, the basic points of muamalah are:

The basic contract of muamalah (business transaction) or akad must be present. Akad is a written agreement between two or more parties and witnessed by other parties. Everything should be written clearly, and nothing is to be hidden (transparentA Simple Introduction to Islamic Finance arrow); including but not exclusive to what is traded, the amount involved, the due date, the installments, the fees, and the like. So the contract should be clear to both sides. This fundamental is taken from Surah Al Baqarah 282. This is to minimize or avoid future dispute on the transaction.

The commercial dealings must only be made on lawful (halal) matters. Hence there should be no dealings in pig farms and/or its derivative or alcohol company, or gambling business/casinoA Simple Introduction to Islamic Finance arrow, speculative transactions, etc.

There should be fairness and openness in trade or business transactions. In some dealings, Shariah audit should exist in every transaction, not only to the institution per se. This requirement benefits all parties involved in the commercial dealings. A transaction should have a win-win result and free from fraud that is unfavorable to one or more parties (aforementioned above in Surah Hud 85-86). A fair trade creates healthy competition and market which is advantageous for the community in general.

There must be assets that are in possession of the seller to be traded and a clear transfer of those assets. As stated in Kitab Al-Buyu Hadits Al Muslim Ch. 8: “It is invalid to sell the commodityA Simple Introduction to Islamic Finance arrow before taking possession of it.”

Islam only recognizes money as a means of exchange, SAR 1 = SAR 1.  And therefore, money is not something to be traded, but asset is. The only cash money lending allowed in Islamic financeA Simple Introduction to Islamic Finance arrow is the Qard Al Hasan contract, where one can lend cash and ask to be returned in a definite time without any increase in the amount. I can give someone SAR100 to be borrowed without that person giving me any asset and ask him to return it only for the same SAR100.

This fourth requirement for a valid muamalah is the one that draw the thick line between the conventional financeA Simple Introduction to Islamic Finance arrow and Islamic finance.

So, what can be defined as usury? Usury is as mentioned in Surah (Ali Imran 3:130)

“There should be no usury, i.e. doubling or quadrupling on the amount of money borrowed”.

It is also taking excessive profits in the trade that will result in one party’s shortfall.

And why the thick line is about asset? That is because in conventional finance, money can be traded i.e. borrowed/lent without the need of an asset transferred. You can even borrow money for buying nothing, in return of interest that can keep increasing. The assets can be both tangible (property, vehicles, equipment, etc) and intangible (services, skills etc.).

As Islam teaches fairness and goodwill among human, therefore this economicA Simple Introduction to Islamic Finance arrow structure is build upon those fundamentals, which is beneficial to all parties involved.

Further discussions will be coming up more in Amuslima about musharakah, mudharabah, murabahah, ijarah, istisna, salam, and their practices in our daily life.

Sources:

An Introduction to Islamic FinanceA Simple Introduction to Islamic Finance arrow by Muhammad Taqi Usmani

And excerpt from different sources

 

Vica Item

A mother of two, currently living in the Netherlands. She has both working and education experience in Finance and Accounting, and enjoys cooking and baking. She loves travel and shopping and has self- published a travel book about Saudi in Indonesian language with her 4 colleagues. Some of her travel notes and tips have been published in some Indonesia’s national media.

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