Features of Islamic Finance


sheeza khan



Features of Islamic Finance

In modern finance, there are several products that fit the different needs of customers, such as the floating payment for specific loans, etc. On the contrary, the Islamic banking is the other end of banking, which is defined as the banking compliant with the Sharia. One of the significant differences from the modern finance is that Islamic Finance prohibits the floating or fixed payment for the loans. In addition, investing shall be considered as normal nowadays. On the contrary, it is prohibited for investment. Although it is a must to obey the Sharia, the degree for the commercial institutions to follow the principles can be varied as time goes by. In this chapter, we will describe several features of Islamic Finance.
Similar to the conventional banking, the Islamic Finance makes money by capital lending. In addition, the core principle of the Islamic Finance is to ensure fair play, adhering the Islamic Law. In order to prohibit the Islam to lend out money with interest, transaction safety nets have been set out to prevent this.
The conventional banking follows the risk-transfer approach for their products. On the other hand, the Islamic Finance illustrates the risk-sharing approach. Therefore, the Islamic Finance introduces a lot of concepts, for example, profit sharing, joint venture, safekeeping, leasing, and cost plus.
For a traditional mortgagetransaction in Islamic Finance, the bank can buy item from the seller, reselling it to make money. At the same time, the bank allows the buyer to pay installments to them. The significant difference from the conventional banking is that the bank cannot have additional penalties for any late payment. In order to protect the bank, they will ask for the registration of the land or goods in the beginning of the mortgage transaction. This type of mortgage is called Murabahah.
This type of mortgage can also apply to the vehicles. For instance, the banks can sell the vehicles in a higher price to debtor, registration of the vehicles under the name of the banks, until the clear payment of the loan.
With a lot of restrictions in Islamic Finance, the banks need to create a lot of innovative approaches to overcome. One of the innovative approaches is called Musharaka al-Mutanaqisa, which transferring the floating rate as rental. The borrower and the bank group as a partnership entity. As a partnership entity, the bank will rent the property to borrower, charging the rent. Per the current equity share, the borrower and the bank share the same money of the property. As the borrower continues to buy the share of the bank, the full equity can then be transferred to borrower, which is the end of the partnership. The Musharaka al-Mutanaqisa allows the bank to follow the floating rates, and the profit can compensate the cost of the banks as interest.
From the above discussion, you shall understand the special features of the Islamic Finance. Compared with the modern finance, the Islamic Finance is the banking compliant with the Sharia.

Posted: 2013-07-18

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