The primary component of Islamic Banking is that the risks of financial dealings should be equally shared between the depositor and the investor, who are bank and its customers. Contrary to the practice of charging interest on any loaned money by most financial institutions, under Islamic banking, it is illegal for financial institutions to charge their client’s interest on any loaned amount, so long as such clients are not running any risks on their own. In addition to this, Islamic banking also prohibits any form of speculative contracts, for example, futures and options. One direct effect of these banking principles is that the nature of the relationship maintained between investors and depositors always remains that of reciprocity.
Under this scenario, banks are very much involved with dealing with their customers’ activities. Contrary to a scenario where a non-Islamic bank can loan some amount to its customers and never bother to monitor how much clients will spend the loaned amount, as long as such clients pay the required interest within the set time limits, Islamic banks always make follow up on their client’s activities to ensure they invest the money well. This is the case primarily because Islamic banks usually lay a strong emphasis on maintaining a profit-sharing relationship with their clients.
On the other hand, Islamic banking is primarily rooted in standard contracts. One of such contracts is the Mudaraba contract. This form of contract involves investing of funds either by the bank or its clients, whereby any profit earned is shared among the two entities in a contract, but in case of a loss, only the investor is supposed to bear it all. The second example of a standard contract is the Musharaka Contract.
Contrary to the Mudaraba contract, here the two parties in a contract must divide any profits of risk of loss o the basis of the amount they have invested. A third example of a standard contract is the Muharaba contract. This form of contract involves the trading of goods and equipment between a bank and its customer for a price that is normally more expensive than their price. The client is supposed to pay this amount in installments depending on the agreed rate and within the set time limits. This type of contract is the easiest and the less risky form of all Islamic contracts because the lending banks always know in advance the number of returns any contract of this form is supposed to earn((Iqbal 18-21).
Most of the derivatives under Islamic banking contain some form of gharar (absolute risk), taking chances, and interest and support estimated activities. Islamic legal rules, more so those that prohibit gharar and the trading of debt for debt does not permit any business deal, which lacks real or productive activities. Any derivatives that involve any form of financial contracts are illegal according to Shariah.
For example, according to the Shariah precepts, it is illegal for a financial institution to trade in Riba-based bonds and forward foreign exchange, which lacks a synchronized mutual exchange pattern. In scenarios where the said assets are equities and commodities, considerations must be made to ascertain whether Riba or Gharar are involved. As indicated by some scholars, ‘arbun’ may be used as the main basis of formulating some type classes of Shariah-compliant alternatives. Arbun is a form of contract where one entity in a contract purchases the right to buy from the other entity certain items for a defined price on a specific date.
This form of contract is a void one according to the three schools of Islamic laws and the Hadith. However, according to the Hanabalah, it is a legal contract; although it also embraces the concept that time should be specified for any option taken. The OIC (Organisation of the Islamic Conference) also accepts it as a legal contract, so long as the time limit concept is taken into consideration. Although some sections of the Islamic organizations accept this type of contract to be a legal one, most derivatives that exist in present markets are not satisfactory when analyzing them from a Shariah point of view, as most of them encompass riba and gharar concepts.
It is assumed that a call option is usually near Bai al-Arbun because the seller is not required to return the premium or down payment to the buyer. This happens when purchasers are unable to exercise the purchase option, which can make them lose the option premium, although such an option has been exercised and the agreement has been ascertained. The case is different when it comes to a Bai al-Arbun because the option premium is normally catered for in the selling price, during the confirmation of the agreement (Iqbal 1-19 and Benlafquih 1).
When it comes to insurance, Islam has its ideology of the entire concept, because of the significance, it places on the need for insurance to operate under principles that comply with provisions of the Shariah Law. As white argues “Islamic insurance has three primary characteristics namely cooperative risk-sharing through the use of charitable donations aimed at ensuring that gharar and riba are eliminated, the well-defined financial separation between the insured and the insurance company, and Shariah-compliant underwriting policies and investment schemes” (White 2).
Within Co-op insurance, the attributes of a cooperative comprise self-responsibility, democracy, fairness, even-handedness, unity, truthfulness, ingenuousness, social responsibility, and being concerned about others. Although mutuality or cooperative risk sharing is the primary principle embraced by Islamic insurance, on its own it cannot form insurance. Hence, Islamic insurance is rooted in numerous relationships, the primary one is a mutual insurance contract between policyholders, them being the primary contributors.
This is the same as a pure mutual insurance relationship while noting the idea of donations instead of premiums. The primary characteristics of cooperative insurance include; firstly, policyholders are supposed to give premiums to a cooperative fund, which should be used as donations to those who may suffer losses (tabarru). A second characteristic is that all policyholders are supposed to receive any surplus, which may be realized from any activity where the cooperative insurance fund has been used. Lastly, all policyholders are legally responsible to make up for any shortfalls, which may result from any transaction involving the use of the cooperative fund (3).
In normal scenarios, an insurance organization is a profit-making entity whose main aim is to ensure that it maximizes the number of returns from any venture through bearing losses of others. In addition, shareholders are the primary owners of this organization, because they are the main recipients of an insurance company’s income at the same time, the main loss bearers or financiers. Contrary to this, Islamic insurance’s primary duty is to manage porpthe portfolios invest wisely in any insurance shares on behalf of its members. The last issue under Islamic banking and finance is the use of Shariah-compliant policies and strategies.
Any Islamic ethical insurers always invest their funds in the most dependable method, mostly in sectors of the economy that are ethically sound and promote environmental stability and the wellbeing of citizens, such as the Norwegian pension fund. Islamic insurance almost resembles conventional insurance, except that its ethical principles must conform to the Islam religion. They are usually under close supervision of the Shariah board; a board that is an integral part of any Islamic insurance company. As per the ethical provisions of this board, any investment or underwriting insurance policies must be free from any form of illegal activities, for example, gambling, tobacco, loans, and pork (White 3-4).
Works Cited
Benlafquih, Christine. The prohibition of interest and the Usury in Islam. Suite101. 2009. Web.
Iqbal, Mazhar. A broader definition of Riba. (n.d). Web.
White, Suzanne. Islamic insurance markets and the structure of Takaful. QFinance (n.d). Web.
Other Sources
- The previous group works done by my group ( James, Hassan, Ali, and me).
- Handouts are given in class (a short review of the historical critique of usury) by Wayne A.M Visser and Alastair McIntosh, searching for the Mecca of finance. ( used them to gain more understanding).