Islamic Financing for the Masses

"I thought Islamic banks don't have a savings account." Well, they do.

The phenomenon of charging interest or markup is as old as it can get. The advent of capitalism in the Renaissance Age only gave rise to it. The ancient Athenian philosopher of the Classical period, Aristotle, denounced the charging of surplus money upon lending.

Woven into our daily lives is the fabric of charging interest, perhaps. The author is unaware of the number of times you might have applied for a phone credit 'advance' and paid back with excessive credit. From an economic standpoint, interest gains favor. Creditors, financiers, and lenders argue that the money loses its 'real value' over time. Hence, charging interest is a wise thing to do. They also provide the argument for opportunity cost. However, from an ethical standpoint, charging interest equates to taking advantage of one's situation. Hence, markup and the charging of it are deemed unethical. Both the proponents and opponents provide valid reasons as per their rationale.

Deemed by many as a 'gunjaish' and a trick to woo religious believers into banking and insurance, at least by fellow Pakistanis, one cannot blame them. After all, the consumer market has witnessed several marketing gimmicks over the years, such as beverage companies producing mineral water to capture the market that hates their beverages and a tobacco company manufacturing nicotine pouches to turn non-smokers into addicts. The same could be valid for Islamic financing.

Islamic financing finds its foundation in the most fundamental characteristic of the Islamic economic system: interest-free. Furthermore, investments are into halal assets and ventures. The Shariah-compliant modes of financing include both banking and non-banking activities. Several usual ones are listed and explained below, with Takaful being the only non-banking mode of finance discussed here:

1. Modaraba
2. Musharakah
3. Ijarah and Diminishing Musharakah
4. Murabaha
5. Tawarruq
6. Takaful.

Modaraba

In Modaraba, the depositor or the investor (Rabb-ul-Maal) provides the bank or the asset manager (Modarib) with the investment money. Contrary to traditional financing, where no loss-sharing occurs, Modaraba bases itself on profit-and-loss sharing (PLS) at an explicitly stated percentage rate. The deposits in a savings bank account get acceptance under Modaraba. Think of Modaraba as follows:

Karim possesses the capital but lacks the insight to invest in assets. He goes to the bank and asks them to provide an ROI against his investment. He also asserts that he can bear a loss if the investment yields poorly. Both parties agree upon a profit-and-loss sharing percentage ratio, say 50-50. Karim is the sleeping partner here who only offers the capital.

Musharakah

Both Modaraba and Musharakah are forms of profit-and-loss partnership. However, they differ in several ways. While Modaraba is strictly limited to a unified role of both the parties involved, Musharakah may include both only offering capital or managing the business alongside. Furthermore, Modarabah is on the consumer's side, while in Musharakah, the bank partners with enterprises to gain profits for itself and the depositor. Think of Musharakah as follows:

A hypothetical company, Helal Inc., lacks both financial capital and management expertise to expand its territory. The company enters into a partnership with the bank, wherein the latter offers both finance and management expertise, thus filling the gap. Both parties act as active partners in this case. However, the bank may also act as a silent partner, offering only the capital.

Ijarah and Diminishing Musharakah

Ijarah is a form of leasing. Leasing refers to providing a usage fee or rental payments by the lessee upon using an asset offered by the lessor. The leased asset remains in possession of the lessee, but the transfer of ownership does not occur.

The Ijarah mode finds its wide usage in mortgage financing. Consider the following example:

Rehan cannot afford to own a house owing to the rising prices. He contacts a bank for a lease contract. The bank (lessor) arranges the housing asset for him and asks for rental payments as long as the property remains in Rehan's (lessee) possession.

What if Rehan later saves enough money to buy the asset from the bank? He can enter into the diminishing Musharakah with the bank. Shares of ownership will transfer to Rehan as he continues the rental payment.

A form similar to diminishing Musharakah is Istisna-cum-Wakala. It is a form of hire-purchase financing, wherein the intention right from the beginning is to own an asset in progression through rental payments.

Murabaha

Consider the following example:

A hypothetical business, Helal Inc., cannot source a product required by its highly lucrative clients. A sole proprietor named Irfan extends the help. In return, Irfan desires a profit.

In the Murabaha mode, Irfan is obliged to disclose the original cost of the product and the profit he desires to make, say the product costs PKR 30,000 and Irfan's profit share is PKR 2,000. The transaction will occur when both parties reach a consensus. Helal Inc. will make a deferred (future) payment to Irfan.

A form similar to Murabaha is Musawamah. Herein the original cost does not require disclosure, and the parties should only agree upon the selling price, say PKR 32,000, and pay the deferred amount.

Tawarruq

Widely applicable on credit card transactions, Tawarruq is a form of Murabaha or Musawamah. Tawarruq-based credit cards are a recent phenomenon in Pakistan. Faysal Bank has launched the first and, by far, the only 'Islamic credit card' here in early 2021 (Noor Card).

Like a conventional credit card, a Tawarruq-based credit card offers instant liquidity from the bank. Here's how Tawarruq works:

Suppose Zohaib wants to spend PKR 20,000 but lacks the required amount. The bank will purchase an asset worth PKR 20,000 and transfer its ownership to Zohaib. However, Zohaib is obliged to pay a surplus amount he agreed upon as a deferred payment.

One of the inherent characteristics of Islamic credit cards is that one cannot perform haraam transactions. Such transactions include but are not limited to gambling, purchasing liquor, and pork meat.

Takaful

Takaful is a form of Islamic insurance. It bears similarity to mutual funds, wherein a pool of investors allocate their money as premiums. This investment money covers insurable risks in case of a claim.

'Takaful' stems from the Arabic term 'Kafalah,' meaning 'to guarantee.' Hence, it bases itself on indemnity, a form of third-party guarantee.

Parties to a Takaful

• The Insured: The party desiring risk coverage.
• Indemnifiers: The pool of investors who offer funds for risk mitigation.
• The Insurer: The party channeling funds from indemnifiers to the insured.

Originally published on Substack. If you liked this or learned something new, please consider subscribing to Finesse for more financial literacy posts. This is the first post. More to come soon.

 

[jamahir]

The article though short serves somewhat to confuse people than explain easily what should be simple, progressive and just economics which is what Islamic economics is about, at least till modern Communism came about :

During the same period (1920s-30s), another (though lesser known) Islamic scholar in undivided India got smitten by the 1917 Russian revolution and Marxism.

Hafiz Rahman Sihwarwl saw Islam and Marxism sharing five elements in common: (1) prohibition of the accumulation of wealth in the hands of the privileged classes (2) organisation of the economic structure of the state to ensure social welfare (3) equality of opportunity for all human beings (4) priority of collective social interest over individual privilege and (5) prevention of the permanentising of class structure through social revolution.

The motivations for many of these themes he drew from the Qur’an, which he understood as seeking to create an economic order in which the rich pay excessive, though voluntary taxes (Zakat) to minimise differences in living standards.

In the areas that Sihwarwl saw Islam and communism diverge were Islam’s sanction of private ownership within certain limits, and in its refusal to recognise an absolutely classless basis of society.

He suggested that Islam, with its prohibition of the accumulation of wealth, is able to control the class structure through equality of opportunity.

The Islamic system in the OP and compared in my quoting is of course one part, the others being marriage law and inheritance law. Now, when we have developed an even more simple and evolved system in any system we should adopt it and so I have devised such a simple socio-economic system which incorporates elements of Islam and of modern moderate Communism that has allowance of an evolved money system, of private businesses and a single, system-managed bank and manages to abolish economic classes ( rich, middle, poor ).

For a further philosophical explanation of progressive economics I will quote part 2 of Gaddafi's Green Book :

The final step is for the new socialist society to reach a stage in which profit and money disappear. Society will become fully productive; the material needs of society will be met. In this final stage, profit will disappear, as will the need for money.

The recognition of profit is an acknowledgment of exploitation, for profit has no limit. Attempts so far to limit profit by various means have been reformative, not radical, intending to prohibit exploitation of man by man. The final solution lies in eradicating profit, but because profit is the dynamic force behind the economic process, eliminating profit is not a matter of decree but, rather, an outcome of the evolving socialist process. This solution can be attained when the material satisfaction of the needs of society and its members is achieved. Work to increase profit will itself lead to its final eradication.

About money disappearing let it be there though in an evolved form as through my proposal for three things : (a). To pay for human labor currently, (b). Until molecular replicators do not emerge to produce things for free, (c). To have a societal understanding to ultimately phasing out money.

 

[RafeyIR]

The article though short serves somewhat to confuse people than explain easily what should be simple, progressive and just economics which is what Islamic economics is about, at least till modern Communism came about :



The Islamic system in the OP and compared in my quoting is of course one part, the others being marriage law and inheritance law. Now, when we have developed an even more simple and evolved system in any system we should adopt it and so I have devised such a simple socio-economic system which incorporates elements of Islam and of modern moderate Communism that has allowance of an evolved money system, of private businesses and a single, system-managed bank and manages to abolish economic classes ( rich, middle, poor ).

For a further philosophical explanation of progressive economics I will quote part 2 of Gaddafi's Green Book :

About money disappearing let it be there though in an evolved form as through my proposal for three things : (a). To pay for human labor currently, (b). Until molecular replicators do not emerge to produce things for free, (c). To have a societal understanding of ultimately agreeing to phase out money.

Appreciate your insights. But the article is particularly about the usual Islamic modes of finance rather than the Islamic economic system in general. I'll cater to the latter part some other day.

 

[fitpOsitive]

View attachment 823947

"I thought Islamic banks don't have a savings account." Well, they do.

The phenomenon of charging interest or markup is as old as it can get. The advent of capitalism in the Renaissance Age only gave rise to it. The ancient Athenian philosopher of the Classical period, Aristotle, denounced the charging of surplus money upon lending.

Woven into our daily lives is the fabric of charging interest, perhaps. The author is unaware of the number of times you might have applied for a phone credit 'advance' and paid back with excessive credit. From an economic standpoint, interest gains favor. Creditors, financiers, and lenders argue that the money loses its 'real value' over time. Hence, charging interest is a wise thing to do. They also provide the argument for opportunity cost. However, from an ethical standpoint, charging interest equates to taking advantage of one's situation. Hence, markup and the charging of it are deemed unethical. Both the proponents and opponents provide valid reasons as per their rationale.

Deemed by many as a 'gunjaish' and a trick to woo religious believers into banking and insurance, at least by fellow Pakistanis, one cannot blame them. After all, the consumer market has witnessed several marketing gimmicks over the years, such as beverage companies producing mineral water to capture the market that hates their beverages and a tobacco company manufacturing nicotine pouches to turn non-smokers into addicts. The same could be valid for Islamic financing.

Islamic financing finds its foundation in the most fundamental characteristic of the Islamic economic system: interest-free. Furthermore, investments are into halal assets and ventures. The Shariah-compliant modes of financing include both banking and non-banking activities. Several usual ones are listed and explained below, with Takaful being the only non-banking mode of finance discussed here:

1. Modaraba
2. Musharakah
3. Ijarah and Diminishing Musharakah
4. Murabaha
5. Tawarruq
6. Takaful.

Modaraba

In Modaraba, the depositor or the investor (Rabb-ul-Maal) provides the bank or the asset manager (Modarib) with the investment money. Contrary to traditional financing, where no loss-sharing occurs, Modaraba bases itself on profit-and-loss sharing (PLS) at an explicitly stated percentage rate. The deposits in a savings bank account get acceptance under Modaraba. Think of Modaraba as follows:



Musharakah

Both Modaraba and Musharakah are forms of profit-and-loss partnership. However, they differ in several ways. While Modaraba is strictly limited to a unified role of both the parties involved, Musharakah may include both only offering capital or managing the business alongside. Furthermore, Modarabah is on the consumer's side, while in Musharakah, the bank partners with enterprises to gain profits for itself and the depositor. Think of Musharakah as follows:



Ijarah and Diminishing Musharakah

Ijarah is a form of leasing. Leasing refers to providing a usage fee or rental payments by the lessee upon using an asset offered by the lessor. The leased asset remains in possession of the lessee, but the transfer of ownership does not occur.

The Ijarah mode finds its wide usage in mortgage financing. Consider the following example:





A form similar to diminishing Musharakah is Istisna-cum-Wakala. It is a form of hire-purchase financing, wherein the intention right from the beginning is to own an asset in progression through rental payments.

Murabaha

Consider the following example:



In the Murabaha mode, Irfan is obliged to disclose the original cost of the product and the profit he desires to make, say the product costs PKR 30,000 and Irfan's profit share is PKR 2,000. The transaction will occur when both parties reach a consensus. Helal Inc. will make a deferred (future) payment to Irfan.

A form similar to Murabaha is Musawamah. Herein the original cost does not require disclosure, and the parties should only agree upon the selling price, say PKR 32,000, and pay the deferred amount.

Tawarruq

Widely applicable on credit card transactions, Tawarruq is a form of Murabaha or Musawamah. Tawarruq-based credit cards are a recent phenomenon in Pakistan. Faysal Bank has launched the first and, by far, the only 'Islamic credit card' here in early 2021 (Noor Card).

Like a conventional credit card, a Tawarruq-based credit card offers instant liquidity from the bank. Here's how Tawarruq works:



One of the inherent characteristics of Islamic credit cards is that one cannot perform haraam transactions. Such transactions include but are not limited to gambling, purchasing liquor, and pork meat.

Takaful

Takaful is a form of Islamic insurance. It bears similarity to mutual funds, wherein a pool of investors allocate their money as premiums. This investment money covers insurable risks in case of a claim.

'Takaful' stems from the Arabic term 'Kafalah,' meaning 'to guarantee.' Hence, it bases itself on indemnity, a form of third-party guarantee.

Parties to a Takaful

View attachment 823948

• The Insured: The party desiring risk coverage.
• Indemnifiers: The pool of investors who offer funds for risk mitigation.
• The Insurer: The party channeling funds from indemnifiers to the insured.

Originally published on Substack. If you liked this or learned something new, please consider subscribing to Finesse for more financial literacy posts. This is the first post. More to come soon.

Islamic Bank based on paper currency that has its power sitting in Britain, in any case can't be Islamic. For Islamic financing, we must get rid of borrowed monetary system and inflation based economy.

 

[RafeyIR]

Islamic Bank based on paper currency that has its power sitting in Britain, in any case can't be Islamic. For Islamic financing, we must get rid of borrowed monetary system and inflation based economy.

We are currently living in a dystopian world overpowered by capitalism. Achieving a pure Islamic economic system utopia is hard to achieve given the Western influence on the financial system.

 

[Mr.Green]

We should adopt Gold and Silver Currency. The present Islamic Banking in Pakistan is just giving Islamic names to Interest based deals.

 

[fitpOsitive]

We are currently living in a dystopian world overpowered by capitalism. Achieving a pure Islamic economic system utopia is hard to achieve given the Western influence on the financial system.

The best way to defeat a system is to getting rid of the system. First step. Kam kerna paryga kafi.

 

[jamahir]

The best way to defeat a system is to getting rid of the system. First step.

Absolutely ! We should start with a clean slate.

Kam kerna paryga kafi.

No need for lot of work. We should keep things in our life as simple as possible. Please read my simple proposal I linked in post# 2.

 

[nahtanbob]

Islamic financing needs to account for time value of money.

The high interest rates of the medieval era reflected the political conditions of the day. Imagine you loaned money to a merchant and the merchant ran away to the next door kingdom. The interest rates reflect the risk of getting back your original principal.

I borrow money at USA at very low rates - 2% for 15 year home purchase loan and 0% for credit card debt

 

[RafeyIR]

We should adopt Gold and Silver Currency. The present Islamic Banking in Pakistan is just giving Islamic names to Interest based deals.

Do you mean gold- or silver-backed currency or gold and silver coins? The latter part is not possible due to the "scarcity of money" problem. Previously, both gold and silver coins were used as media of exchange but they were not considered a viable means, primarily due to the costly discovery, mining, and minting of gold coins.

 

[Mr.Green]

Do you mean gold- or silver-backed currency or gold and silver coins? The latter part is not possible due to the "scarcity of money" problem. Previously, both gold and silver coins were used as media of exchange but they were not considered a viable means, primarily due to the costly discovery, mining, and minting of gold coins.

I mean Gold and Silver Coins. Using it will reduce inflation that is created due to printing more and more money by the Reserve Banks.

 

[RafeyIR]

Islamic financing needs to account for time value of money.

The high interest rates of the medieval era reflected the political conditions of the day. Imagine you loaned money to a merchant and the merchant ran away to the next door kingdom. The interest rates reflect the risk of getting back your original principal.

I borrow money at USA at very low rates - 2% for 15 year home purchase loan and 0% for credit card debt

The State Bank has low-interest options for business and house financing though. Private banks won't change their course unless the State Bank intervenes.

I mean Gold and Silver Coins. Using it will reduce inflation that is created due to printing more and more money by the Reserve Banks.

Historical evidence shows that even gold discoveries have caused inflation. Moreover, gold and silver are natural resources and scarce. They cannot completely need the monetary needs of the large population.

 

[jamahir]

Islamic financing needs to account for time value of money.

The high interest rates of the medieval era reflected the political conditions of the day. Imagine you loaned money to a merchant and the merchant ran away to the next door kingdom. The interest rates reflect the risk of getting back your original principal.

1. So to minimize your risk on one merchant you want to impose interest-based loans on the remainder of the population ?

2. Why is loan giving even a private thing ? Loans should be given by the governing system so that a private person doesn't have the opportunity to see even this as profit-making enterprise. I quote that section of Gaddafi's Green Book :

The final step is for the new socialist society to reach a stage in which profit and money disappear. Society will become fully productive; the material needs of society will be met. In this final stage, profit will disappear, as will the need for money.

The recognition of profit is an acknowledgment of exploitation, for profit has no limit. Attempts so far to limit profit by various means have been reformative, not radical, intending to prohibit exploitation of man by man. The final solution lies in eradicating profit, but because profit is the dynamic force behind the economic process, eliminating profit is not a matter of decree but, rather, an outcome of the evolving socialist process. This solution can be attained when the material satisfaction of the needs of society and its members is achieved. Work to increase profit will itself lead to its final eradication.

I borrow money at USA at very low rates - 2% for 15 year home purchase loan and 0% for credit card debt

The State Bank has low-interest options for business and house financing though. Private banks won't change their course unless the State Bank intervenes.

Let us not get into unnecessary technical details of loan mechanisms and lose sight of how the overall socio-economic system should be. Housing is a basic human right and it has to be provided by the system. In USA the government spent 700+ billion dollars as the military budget for just 2020-21 when it should instead spent that financial and other resources on giving nice, free homes to the many American homeless and free homes to other citizens who are told by the system currently to buy their home on loan ( interest-based ) where they have to spend 15 to more years repaying that loan when the system could have easily constructed free homes for the citizens and the citizens could have spent that money, within an evolved socio-economic system, to perhaps start a business.