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The principles of Islamic finance
Islamic finance operates in accordance with the principles of Islamic law (or Shariah). The basic principle of Islamic finance is underlined by the prohibition of investment in interest-based ventures and businesses that provide goods and services considered contrary to its principles like tobacco, alcohol, gambling, vulgar entertainment and conventional finance.
Another fundamental principle of Islamic finance is highlighted in the sharing of profit and loss between parties in a business transaction. Common terms used in Islamic finance include profit sharing (Mudharabah), joint venture (Musharakah), leasing (Ijarah), safekeeping (Wadiah) and cost plus (Murabahah). Currently estimated to be worth around US$1 trillion globally with 300-plus Shariah compliant financial institutions operating in more than 75 countries today; this industry is growing at a remarkable pace of approximately 15%-20% on a yearly basis, thus representing a vast practice which has developed its presence on a global scale. Despite a widespread misconception, Islamic finance does not require specific laws and is not limited to the Muslim community. Except for several predictable prohibitions mentioned earlier, Islamic finance solutions are applicable everywhere and by anyone.
It is of standard practice that Islamic banks and banking institutions that offer Islamic banking products and services are required to establish a Shariah Supervisory Board to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. An essential ingredient is a regulatory framework that can accommodate Islamic finance principles and a regulator that is prepared to work with Islamic institutions to overcome technical hurdles. There must also be a tax regime that enables Islamic financing structures and products to be treated in an equivalent manner to their conventional counterparts.
The appeal for Islamic finance has become infectious to an extent where the largest Muslim populations in the world, most notably India has developed a profound interest for Shariah compliant products to cater for its community and business sector. In view of capitalizing on the opportunities that Islamic finance has to offer, the Indian government and corporates have taken the initiative to closely examine which Shariah compliant companies and sectors are able to further contribute to the development of Shariah market capitalization in India. This is solely due to the fact that India believes that by complying with the economic laws of Shariah, she can become an attractive destination for Islamic investments. The Islamic finance sector in the United Kingdom has also seen enormous growth both domestically and internationally. London is one of the top five financial centres in the world for Islamic finance.
Islamic finance has always been known and seen as a form of socially responsible investing whereby Shariah law requires that investments made have to be based on tangible assets and that lenders and borrowers in a business transaction share profits and losses. It is unfortunate however, that the rapid growth of Islamic finance has converted itself as a breeding ground for socially irresponsible investors who are ignorant about the social impact of investment. It is not unusual to come across conventional profit-driven investments these days that are dressed up to look like Islamic finance. The presence of Shariah-dress investments only serves as an invitation to unethical profit chasers who seek to threaten the health and reputation of the Islamic financial market. As such, it is vested within the powers of national financial watchdogs to ensure that Shariah-dressed investments are not part of an Islamic financial market that only decreases its immunity to the global financial crisis.
The issuance of sukuks, which conform to Islam’s prohibition of receiving or paying interest, has come under intense scrutiny in recent times over fears of a debt default in Dubai. Commonly referred to as Islamic bonds, companies that issue sukuks make payments to investors using profits from the underlying business instead of paying interest. The Dubai crisis has sparked speculation that Islamic finance is no different from conventional finance that led to the financial turmoil a couple of years ago.
However, many fail to understand that the main cause of the Dubai crisis is purely one of a credit issue where Dubai World and its subsidiary Nakheel have over borrowed and over expanded within the real estate and tourism sectors to an extent where near-term repayment obligations cannot be met. In short, the Dubai crisis demonstrates the fragility of the financial and economic system in Dubai, which is one based on excessive borrowing to finance excessively luxurious projects without giving much consideration to the economic feasibility of such projects. Notwithstanding, the assistance by Abu Dhabi in the form of USD10 billion has allayed all the fears.
Despite reservations held by several parties that Islamic finance is just as susceptible to the global economic turmoil, many still maintain that there is vast potential and opportunities for financial institutions to tap in the field of Islamic banking and finance. With the adoption of stringent Shariah principles, Islamic finance offers a huge alternative economic opportunity to the conventional methods that investors have become accustomed to. Many countries globally from Europe, Middle East, Asia, Australia and even the United States have realized the importance of Islamic finance. Malaysia, being one of the pioneers of Islamic finance and location of the highest number of sukuks issued globally remains at the forefront which provides guidance to others in terms of regulatory and legal aspects.