The intent of this study is to analyze the hazard direction agreements and equipments in Islamic finance as may be imitative from the Sharia’ah maxims and opinions in new merchandises specialy. it suggests methods of incorporating hazard extenuation within new Islamic funding merchandises every bit good as chief insurance, the issues of 3rd party warrant, chief insurance and return widening.
First the foundation of Islamic fiscal merchandises and hazards involved is being discussed. The hazard of Islamic fiscal merchandises are and immediate result of nature of Islamic finance contracts are the portion of study as good. Report includes the general features of fiscal merchandises in Shari ah the principle of the prohibition of Riba and the aims “ the Maqasid ” of this prohibition.
Islamic fiscal merchandises hazards
In a recent book on Risk Management in Islamic Banks,1 Khan and Ahmad argued that Islamic Bankss non merely confront the type of hazards that conventional Bankss face but they are besides confronted with “ new and alone hazards as a consequence of their alone plus and liability constructions. ” Harmonizing to Khan and Ahmad, this new type of hazards is an immediate result of their conformity with the Shari’ah demand. They added that even in respect to common or conventional hazards, the nature of hazards that Islamic Bankss face is different from those counterpart hazards faced by conventional Bankss. The obvious deduction of this statement is that Islamic Bankss need variant “ hazard designation procedures ” and different hazard direction attacks and techniques and necessitate different sort of supervising as good. Similar statement appeared a few old ages before in an IMF publication by Luca Errico and Mitra Farahbaksh.2 Although they conceded that capital minimal demand should take into consideration assets composing, i.e. , the PLS investings versus non-PLS investment,3 they argued that the capital minimal demand needed to for hazards coverage should be higher in Islamic Bankss that in conventional Bankss because their PLS assets are non collaterized.
The chief focal point of these two Hagiographas is on Muslim Bankss particularly from the point of position of supervisory governments and minimal capital demand. Islamic fiscal merchandises pose a different sort of hazard challenges that focal point of the hazard to investor and morticians. Undertaker hazard relates basically to covering the issued merchandise and the experience in the Middle East, South East Asia and Pakistan indicates that there is a strong appetency for Islamic merchandises to the extent that each issue is ever over-subscribed and buyer clasp on to them that small room is left for a secondary market. Investors ‘ hazards is a affair of concern for donees of new Islamic fiscal merchandises and Islamic bankers and public issuers look for agencies of extenuating these hazards in expectancy that demand will sometime diminution and new motive must be offered to investors. To understand the nature and comparative significance of hazard in Islamic fiscal merchandise we need to look at the chief features of fiscal contracts as given in the Shari’ah and so analyze the hazard profile of each of these contract/products.
Prohibited Interest
Islam, like other monotheistic faiths, condemns and prohibits Riba. The prohibition of Riba in Islam is given in strong and distinct footings. The Qur’an
Says “ But God has permitted sale and prohibit the Riba ; ” ( 2: 275 ) and, “ God destroys/eliminates the Riba ; ” ( 2: 276 ) and, “ O ye who believe, fear God and discontinue what remains of the Riba if ye are so trusters ; but if ye do it non, take notice of war from God and His Messenger ” ( 278-9 ) . No other wickedness is prohibited in the Qur’an with a notice of war from God and His Messenger!
The Traditions of the Prophet Muhammad contains several statements that condemn Riba and see its patterns as one of the gravest wickednesss that invoke a expletive or wrath from God. In one of the Sayings, the Prophet references that: “ The Wrath of God is on the taker of Riba, its giver, its author and its two informants.
Riba
To be exact, Riba is defined, in respect to fiscal minutess, as any contractual increase in a loan or debt due to the clip component. This is precisely what we know today as involvement. Obviously, the Shari’ah does non acknowledge a opposite number for this increase. Consequently, one time a debt is created ( notice that a loan creates a debt ) any increase in the debt is Interest and it is the Prohibited Riba harmonizing to the Islamic faith.
Aims of the prohibition of involvement
Consequently we can set up the aim of Shari’ah from the prohibition of involvement as follows:
1 ) Confirming the Shari’ah feature of pragmatism and keeping its internal consistence in non leting any dealing that is non a existent life activity.
2 ) Forbiding debts trading and interchanging and similar unrealistic strictly bad minutess that are non based on existent production or exchange
such making unreal assets like index units belongingss because these activities doe non make value and merely reassign wealth between persons and airting the human and other resources used in trading debts toward existent production of goods and services.
3 ) Preventing debt discounting and rescheduling for increase because these are non-productive activities and merely reassign wealth from one individual to another. The alternate the Shari’ah provides for rescheduling is interestingly mentioned in the Qur’an within the same sequence of Poetries that is: giving clip to pay or even abandoning the principal of the debt itself. On the other manus, the Shari’ah permits discounting for early payment provided it does non go a concern pattern ( non in the contract and merely between the two parties ) .
4 ) Preventing the usage of concern fundss for what can be tagged as ‘Abath O«O?O? and directing personal finance to where it belong as a personal service based on direct contact and engagement between the finance supplier and user. The reply to the inquiry “ who will give you a loan? ” becomes “ your female parent or a individual who knows and loves you ” This does non intend that a personal loan is non utile ; it instead means that it must stay personal and non changed into concern. Giving a loan is even reward able by God as known in the Shari’ah.
5 ) Re-channelling all concern financing toward the production and exchange of goods and services or toward value creative activity and shutting all the utilizations of finance that unnecessarily blow up the measure funding in a society relation to production and exchange.
Finally, it should be noted that the prohibition of Riba ( involvement ) ne’er meant to be a prohibition of honoring funding in general and debt-creating funding in specific.
Hazard Mitigation in Islamic Financial merchandises
To minimise the investors ‘ hazard in new Islamic fiscal merchandises, particularly Sukuk and corporate investings, a smattering of agreements can be used, viz. : gross sharing, service and usufruct-based finance, chief insurance, collaterals, 3rd party warrant and contrary and line-or-credit Murabahah.
Gross sharing
The thought of gross sharing is based on using the Muzara’ah methodological analysis to fund proviso in Mudharabah. While Mudharabah assigns a portion of net net income to the fund supplier ( Rabb al Mal ) , gross sharing funding
because it is non readily available for buying good and factors of production as it takes clip and attempt to roll up it. It requires an expressed and separate bureau contract that may affect fees and other charges. But once it is collected a sharing-based fiscal relationship may be contracted
delegate a portion of the gross gross to the supplier of assets that are used in the production procedure. Revenue sharing funding is therefore a combination of Wakalah to buy or construct fixed assets and a Muzarah based partnership between assets proprietor and assets operator.
Third party warrant: sedimentation warrant
The pattern of a 3rd party warrant is applied to Islamic bank investing sedimentations when the authorities provides such a warrant with no charge to the depositary Bankss or at least for the parts of the authorities or cardinal Bankss to a public sedimentation warrant corporation as it is done in Sudan. However, the same rule is besides invoked by sedimentation warrant financess nourished by tax write-offs from Arbab al Mall ‘s net incomes before their distribution. Such financess can besides be created for Sukuk and the warrant can be extended to cover the principal ; and a return on it.
Hedging through options
Finally, fudging bing places may be differentiated from trading options.
While purchasing options for the intent of monetary value guess may be argued as fabricated and profiteering without having a existent plus that may hold an independent demand and supply for its ain intrinsic utility/productivity, covering an bing place through purchasing or selling an option may be looked at as a agency to cut down possible fluctuations in monetary values and so chasten monetary value guess.
Consequently, one manner fudging through options can be found utile and allowable, a affair that can besides be used in Islamic fiscal invention.
Before reasoning this subdivision it should be noted that the regulations stipulated in the Basel II agreement provide a moderately equal footing for cut downing recognition hazard, market hazards and default and moral jeopardy hazards and Muslim Bankss should truly look at the Basel II demand in a positive mode.
Decision
A word is needed for decision: We have within the bounds of Shari’ah a assortment of agencies that makes the hazard direction in advanced Islamic fiscal technology a ambitious sphere that does non go forth room to fall back to doubtful and counterproductive tools of funding that really frequently contradict the kernel and basic aims “ Maqasid ” of the prohibition of involvement and other ordinances of Islamic funding.