Introduction
One of the fastest developing industries in the financial service sector is Islamic finance. Over the past two decades, Islamic finance has witnessed an annual growth of over 10%. This industry has been growing exponentially in the past three decades with total global asset of the industry surpassing $2 trillion as at mid 2018 when this article was first written [1].
This is evident in the tremendous rise in the demand for and provision of Islamic financial services. In the west today, Britain is the global hub for Islamic finance being the first country outside the Islamic world to issue a sovereign sukuk (bond) worth £200 million in the year 2014.[2]
Furthermore, Islamic finance has shifted from being a mere theoretical intellectual discourse to a practical reality. Government of different countries of the world are now subscribing to Islamic financial products and services. The shift of focus to this sector is further evidenced by the increasing number of academic programs in this field.
Many universities in the world today now administer academic and executive programs in Islamic banking and finance in a bid to meet the growing demand for Islamic finance professionals. Few notable examples include University of Reading, Durham University, Loughborough University, Aston University and several others in different parts of the world outside the UK.
Owing to this growing popularity, there is the need for the general public to have a considerable knowledge of what Islamic finance entails in order to better appreciate the value that comes with it.
This article attempts to give an introductory insight into the meaning of Islamic finance, its components and the salient features which distinguish it from its conventional counterpart. Also, most of the examples to be cited in this article shall relate to the Nigerian scene.
Meaning of Islamic finance
Islamic finance is a term used to refer to any financial arrangement, business or system which is in tandem with the principles and provisions of the Shariah (Islamic law).[3] In other words, its affiliation to Islam is derived from the fact that its philosophical underpinnings are sourced from the Qur’an and prophetic traditions.
Due to its strong emphasis on social responsibility, ethics and fair dealing, Islamic finance is now seen to be a veritable alternative to the conventional financial system.
It is noteworthy to state that Islam as a religion cuts across all facets of human lives and endeavours. The laws of Islam cut across all aspects of human endeavours including politics, economics, and societal formation. Thus, terms like Islamic political system, Islamic economic system and Islamic financial system are commonly used in the literature.
These various Islamic systems possess their peculiar characteristics that distinguish them from their conventional counterparts.
Components of Islamic finance
Islamic finance has three major components which are Islamic banking, Islamic insurance (Takaful) and Islamic capital market. The most popular and perhaps the most developed of this sector is the Islamic banking otherwise called Islamic banking and finance. Islamic banking alone accounts for the greatest proportion of the entire industry’s asset.
In 2016, the Central Bank of Nigeria (CBN) granted Jaiz bank Plc a national banking license to operate as a full-fledged non-interest bank. Before this time, it was operating only as a regional bank. Aside Jaiz, some other conventional banks have an Islamic finance window through which they practise non-interest banking.
Notable examples include Stanbic Ibtc, Sterling Alternative Finance, a unit of Sterling Bank, Taj Bank and a number of other non-interest banking windows being operated by commercial banks across the country.
Likewise, there are Islamic insurance firms though with lesser popularity when compared with Islamic banks. A very good example is Jaiz Takaful Insurance Company, African Alliance Takaful, and Halal Takaful Nigeria, an arm of Cornerstone Insurance Plc. Unlike the conventional insurance, Islamic insurance introduced the concept of donation among the participants or policy holders as against the sale of indemnity for insurance premium in conventional insurance.
The Islamic finance industry is sometimes tagged non-interest bearing finance in some quarters due to its strong prohibition of interest rate.
Salient Features of Islamic Finance
Islamic finance is characterized by certain elements and traits which defines its uniqueness and also constitute its philosophical underpinnings. The decision as to whether an Islamic finance product is shariah-compliant or not depends on its ability to adhere to these fundamental features.
i. Prohibition of Riba (Interest/Usury)
Riba is an Arabic term meaning interest or usury. It simply refers to interest on loans or the offer of a certain value in return for a predetermined higher value. The Qur’an states:
“……but Allah has permitted trade and forbidden usury…….” Q.2 Verse 275
By implication, Mr. A cannot offer a sum of N1,000 as loan to Mr. B in return for N1,100. To many, this could be seen as a denial of the time value of money which is an established concept of finance.
However, Islamic finance recognizes the time value of money and clearly makes provision for it in certain transactions. What is actually prohibited however is the act of making time value of money a predetermined value that constitutes an element of a lending relationship.
Also, interest in its original form is an advantage to one party and a disadvantage to another party without any economic justification. Prophet Muhammad (Peace Be Upon Him) was reported to have said: “ gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salts for salts, like for like, equal for equal, hand-to-hand, if the commodities differ, then you may sell as you wish provided the exchange is hand to hand.”
From this narration, it could be understood that for Riba to be avoided in an exchange involving two similar items e.g. currency or commodities, both must be exchanged for equal amount and on the spot.
ii. Prohibition of Excessive Risk and Uncertainty (Maysir/ Gharar)
Islamic finance generally prohibits excessive risk and uncertainty in all possible terms. Gharar is risk, uncertainty and Maysir is gambling or speculation. While it is known that risks cannot be taken from business dealings, what Islamic finance prohibits is excessive risk and uncertainty.
Gharar usually come in the form of a lack of knowledge and control of the outcome of a transaction which could be detrimental to a party to the transaction.
Islamic finance prohibits uncertainty relating to the quality, quantity, term of delivery and other sales term of a transaction.
For instance, a person cannot sell a fish in a pond, the unborn calf in its mother’s womb, a bird in the air and a pregnant camel or any other transaction that is not clearly spelt out or which contains elements of uncertainty. In all these cases, the objects of the transactions are uncertain and there is lack of transparency in all.
Though the prohibition of gharar and maysir is no doubt less popular than that of Riba, there seems to be a consensus among scholars that it can make a contract null and void.
iii. Prohibition of Trading/Investment in Unlawful Commodities and Services
Apart from the above prohibitions which constitute the salient features of Islamic finance, Islamic finance also prohibits trading in commodities that are deemed illegal in the Shariah. For instance, pig meat, gambling, alcohol, cigarette and other intoxicants are prohibited in the Shariah. It is thus forbidden to engage in business dealings whose underlying commodities or assets relate to prohibited good and services.
In a Hadith, the Prophet (PBUH) says: “Whenever Allah makes something forbidden, He also prohibits trading in such thing or commodity”. Islamic investment management firms such as Lotus capital and Islamic banks seek to ensure that monies deposited with them are invested in Halal (permissible) channels.
iv. Need for An Underlying Asset
Islamic finance emphasizes so much on the need for an underlying asset in every transaction involving sale or lease. In fact, a sale or lease transaction is null and void ab initio if an underlying asset does not exist.
For instance, in a Sukuk[4] contract where a certificate is issued as an evidence of ownership of certain right, the return on investment is tied to the return generated from the underlying asset. The underlying asset could be a fixed asset such as an investment property or a financial asset which may take the form of equity.
v. Overriding Principles of Islamic Law
Islamic finance is governed by Fiqh al muamalaat ( the Islamic law of business transactions). These laws are what determine what is permissible or not in the Islamic finance framework. As a result, Shariah scholars are a major backbone for this sector.
For every major Islamic financial institution, there must be a Shariah advisory board that would perform the oversight function of ensuring that the products being structured adhered strictly to the laws of the Shariah.
Islamic banks such as Jaiz Bank has a Shariah advisory board sometimes regarded as a committee of experts.
Likewise, the Central Bank of Nigeria has an advisory board made up of Islamic finance scholars and shariah experts who help in ensuring that all policies and activities of the IFI are in line with the Islamic law.
Key Players in the Islamic Financial Service Industry
The key corporate players in the Islamic financial service industry consist mainly of the Islamic financial institutions and the regulatory agencies. At the global level, few notable institutions and regulatory agencies are as follows:
a) Islamic Development Bank (IDB) based in Jeddah, Saudi Arabia
b) Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
c) Islamic Finance Advisory and Assurance Services (IFAAS)
d) Islamic Research and Training Institute (IRTI)
e) International Centre for Education in Islamic Finance (INCEIF), a global University based in Malaysia dedicated to Islamic finance education.
f) Islamic Financial Services Board (IFSB), an international standard setting organization
Bibliography
1) Hans Visser (2009). Islamic Finance Principles and Practice. Edward Elgar Publishing Limited
2) Ibrahim Warde (2000). Islamic Finance in the Global Economy. Edinburgh University Press
3) Introduction to Islamic Finance by Chartered Institute of Management Accountant (CIMA)
4) Abu Umar Faruq Ahmad and M. Kabir Hassan: The Time Value of Money Concept in Islamic Finance
[1] https://www.gulf-times.com/story/596054/Islamic-finance-industry-assets-surpass-2tn-mark
[2] https://www.gov.uk/government/news/government-issues-first-islamic-bond
[3] The Shariah is the Islamic law which represents the code of conduct for Muslims. This body of laws takes its source from the Qur’an, Sunna (prophetic tradition) and the consensus of scholars.
[4] Sukuk is a term used to refer to the Islamic bond.
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