ISLAMIC FINANCE

Company Analysis Report 2018 - 20

Title of the Project: ISLAMIC FINANCE

Submitted by:
Name of Faculty Guide: Professor Krupesh Thakkar Name of the Student: Rituja Nair
Designation: Roll No.: PGDM182051910
Program: PGDM-IFM
Batch: IFM

Institute for Technology and Management

Plot No. 25 / 26, Institutional Area,
Sector – 4, Kharghar, Navi Mumbai

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CERTIFICATE FROM THE FACULTY GUIDE

IMPACT OF ISLAMIC FINANCE ON INDIAN ECONOMY

This is to certify that the Project Work titled IMPACT OF ISLAMIC FINANCE ON INDIAN ECONOMY

(title) is a bonafide work carried out by Ms.RITUJA SUDARSHAN NAIR (name of the student) Roll No.

PGDM182051910, a student of PGDM program 2018 – 2020 of the Institute for Technology &

Management, Kharghar, Navi Mumbai under my guidance and direction.

Signature of Guide : __________________________

Name of Guide : PROFESSOR KRUPESH THAKKAR

Designation : HEAD OF DEPARTMENT (FM)

Date: _____________ Place: ________________

CONTENT
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Title of the project 1

Certificate 2

Introduction 4

Principles of Islamic Finance 6-10

History 11-13

Why is Islamic finance different from conventional finance 14-16

Literature Review 17

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INTRODUCTION
Islamic finance is a financial system that operates according to
Islamic law (which is called sharia) and is, therefore, sharia-
compliant. Just like conventional financial systems, Islamic finance
features banks, capital markets, fund managers, investment firms,
and insurance companies. However, these entities are governed
both by Islamic law and the finance industry rules and regulations
that apply to their conventional counterparts.

Although the Islamic finance industry itself is quite young, Islamic

theories of economics have existed for more than a millennium; by
the mid-12th century, in fact, many Muslims scholars had presented
key concepts of Islamic economics that are still relevant today.

But political and social turmoil put the brakes on Islamic finance for
a very long time; only in the 20th century did Muslim scholars and
academics seriously begin to revisit these topics (and, in doing so,
set the stage for the modern Islamic finance industry to emerge in
the 1970s).

THE SEARCH FOR BALANCE

Islamic economics is based on core concepts of balance, which
help ensure that the motives and objectives driving the Islamic
finance industry are beneficial to society.

• Balancing material pursuits and spiritual needs

• Balancing individual and social needs

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THE BELIEF THAT ALLAH IS THE OWNER

OF ALL WEALTH
A core concept of Islam is that Allah is the owner of all wealth in the
world, and humans are merely its trustees. Therefore, humans need
to manage wealth according to Allah’s commands, which promote
justice and prohibit certain activities.

At the same time, Muslims have the right to enjoy whatever wealth
they acquire and spend in sharia-compliant ways; they don’t need
to feel shame about being wealthy as long as their behavior aligns
with Islam.

THE PROMOTION OF A RESPONSIBLE

FREE-MARKET ECONOMY
A Muslim believes that Islam doesn’t restrict economic activity but
instead directsit toward responsible activity that benefits other
people, protects the earth, and honors Allah. In other words, Islam
allows for a free-market economy where supply and demand are
decided in the market — not dictated by a government. But at the
same time, Islam directs the function of the market mechanism by
imposing specific laws and ethics.

A key purpose for imposing these laws and ethics is to promote

social justice; Islam and social justice are inseparable. Therefore,
social justice is a key concept of the Islamic finance industry.

Islam tries to achieve social justice in the economy in many ways:

• Promoting adherence to Islam

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• Requiring zakat (taxing the property of people who acquire

wealth and distributing that tax to people in need)

• Defining the state’s obligations

• Prohibiting usury (interest)

• Encouraging shared risk

ISLAMIC FIRMS FOLLOW A SET OF KEY

PRINCIPLES
Based on the core concepts of Islamic economics, Islamic finance
institutions adhere to certain principles that distinguish them from
conventional finance:

• Prohibiting interest (riba)

• Steering clear of uncertainty-based transactions (gharar)

• Avoiding gambling (maysir or qimar)

• Avoiding investment in prohibited industries

KEY SHARIA PRINCIPLES AND

PROHIBITIONS IN ISLAMIC FINANCE
Sharia law differentiates Islamic finance from conventional finance.
The Islamic financial system is constructed on economic concepts
specified by sharia — a code of conduct that guides Muslims (the
followers of Islam) in social, economic, and political matters. Sharia
promotes balance and justice and discourages behaviors of excess.
Some of the core ideas promoted by sharia include the following:

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• Allah (God) is the owner of all wealth. Humans are merely

the trustees of wealth, which belongs to Allah. Humans must
manage wealth according to Allah’s commands, which
promote justice and prohibit certain activities, including
wasting or destroying resources. Muslims have the right to
enjoy whatever wealth they acquire and spend in sharia-
compliant ways.
• Material pursuits must be balanced with an individual’s
spiritual needs. A Muslim’s economic activities and pursuit of
wealth should balance with the spiritual aspects of life.
Economic activity conducted according to sharia is, itself, an
act of worship, but finding balance between economic
activities and spirituality is key. A Muslim is expected to seek
moderation in the material world — to avoid being either
miserly or too materialistic.
• An individual’s needs must be balanced with society’s
needs. A Muslim needs to consider society in general when
enjoying Allah’s bounties. These considerations include
promoting justice in all economic activities, remembering that
all people have mutual responsibility for all others, and using
the earth’s resources wisely.
• Economic transactions should take place within a just,
responsible, free-market economy. Islam does not restrict
economic activity but instead directs it toward being
responsible to other people, to the earth, and to Allah. Islam
allows for a free-market economy where supply and demand
are decided in the market, but it directs the function of the
market mechanism by imposing specific laws and ethics. A

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primary purpose for imposing these laws and ethics is to

promote social justice: a balance in which wealth is not
accumulated only by a few while most others suffer.
In support of these principles, sharia prohibits business transactions
based on the following:

• Interest: Riba, the Arabic word for interest, means to

increase, grow, or multiply into more than what would be due.
Riba is prohibited by Islam because it creates societal
injustice; in a riba-based transaction, the owner of the wealth
gets return without making any effort, and the borrower carries
all the risk.
• Uncertainty: The Arabic word gharar means uncertainty or to
cheat or delude. Transactions based on gharar are unclear or
ambiguous; not everyone involved knows what to expect and
can make an informed decision. Gharar exists when two
parties enter a contract and one party lacks complete
information or when both parties lack control over the
underlying transaction.
• Gambling: Two Arabic words — maysir and qimar — refer to
transactions that involve gambling. Maysir is the acquisition of
wealth by chance instead of by effort. Qimar refers to a game
of chance. Both types of transactions are based on
uncertainty; no one can know how a gamble will pay off.
• Prohibited products and industries: Islam prohibits
products and industries that it considers harmful to society and
a threat to social responsibility. Examples include alcohol,
pork, prostitution, pornography, tobacco, and any products
based on uncertainty or gambling.

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ISLAMIC FINANCIAL PRODUCTS BASED

ON SHARIA-COMPLIANT CONTRACTS
In accordance with Islamic law (sharia), Islamic financial products
are based on specific types of contracts. These Sharia-compliant
contracts support productive economic activities without betraying
key Islamic principles as some conventional financial products do.
Sharia-compliant contracts cannot create debt, cannot involve the
payment of interest, and must provide for a sharing of risk and
responsibility between the involved parties.

To be valid, an Islamic contract must feature subject matter that is

lawful, has value for a Muslim, and is specific enough to avoid
uncertainties. The service or asset described in the contract
generally must exist when the contract is being created, must be
owned by the seller (hence prohibiting short sales of stock, for
example), and must be deliverable.

Here are some of the most commonly used contracts in Islamic

finance:

• Contracts of partnership allow two or more parties to

develop wealth by sharing both risk and return:

o Mudaraba: One party gives money to another party,

which invests it in a business or economic activity. Both
parties share any profit made from the investment
(based on a pre-agreed ratio), but only the investor loses
money if the investment flops. The fund manager loses
the value of the time and effort it dedicated to the
investment. (However, the fund manager assumes

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financial responsibility if the loss results from its

negligence.)
o Musharaka: This contract creates a joint venture in
which both parties provide investment capital,
entrepreneurial skills, and labor; both share the profit
and/or loss of the activity.
• Contracts of exchange are sales contracts that allow for the
transfer of a commodity for another commodity, the transfer of
a commodity for money, or the transfer of money for money:

o Murabaha: In this cost plus contract, an Islamic financial

institution sells a commodity to a buyer for its cost plus
the profit margin, and both parties know the cost and the
profit in advance. The buyer makes deferred payments.
o Salam: In this forward contract, the buyer (or an Islamic
financial institution on behalf of the buyer) pays for
goods in full in advance, and the goods are delivered in
the future.
o Istisna: This second type of forward sale contract allows
an Islamic financial institution to buy a project (on behalf
of the buyer) that is under construction and will be
completed and delivered on a future date.
• Contracts of safety and security are often used by Islamic
banks; these contracts help individual and business customers
keep their funds safe:

o Wadia: A property owner gives property to another party

for the purpose of safeguarding. In Islamic banks,
current (checking) accounts and savings accounts are
based on the wadia contract.
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o Hiwala: Debt is transferred from one debtor to another.

After the debt is transferred to the second debtor, the
first debtor is free from her obligation. This contract is
used by Islamic financial institutions to remit money
between people.
o Kafala: A third party accepts an existing obligation and
becomes responsible for fulfilling someone’s liability. In
conventional finance, this situation is
called surety or guaranty.
o Rahn: A property is pledged against an obligation. A
customer can offer collateral or a pledge via a rahn
contract in order to secure a financial liability.

TIMELINE: THE EVOLUTION OF ISLAMIC

FINANCE
The modern Islamic finance industry is young; its timeline begins
only a few decades ago. But Islamic finance is evolving rapidly and
continues to expand to serve a growing population of Muslims as
well as conventional, non-Muslim investors.

The core concepts of Islamic finance date back to the birth of Islam
in the 6th century; Muslims practiced a version of Islamic finance for
many centuries before the Islamic empire declined and European
nations colonized Muslim nations. The modern Islamic finance
industry emerged only in the 1970s, in large part because of efforts
by early 20th-century Muslim economists who envisioned
alternatives to conventional Western economics (whose interest-
based transactions violate Islamic law).

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Here are some of the key events in the short history of the modern
Islamic financial industry:

• In 1963, the Mit Ghamr Savings Bank in Egypt was opened,

becoming the first modern Islamic bank on record.
• Also in 1963, the Pilgrims Saving Corporation of Malaysia —
although not a bank — began to incorporate basic Islamic
banking concepts.
• In 1975, the Islamic Development Bank opened in Saudi
Arabia and gave the Islamic finance industry an international
presence. It recruited member countries and then offered
them financial products to promote economic and community
development.
• In 1979, the first Islamic insurance (or takaful) company — the
Islamic Insurance Company of Sudan — was established.
(Muslims cannot purchase conventional insurance products
because those products involve interest-based transactions,
uncertainty, and gambling, which are all prohibited by Islamic
law.)
• In 1986, the Amana Income Fund, the world’s first Islamic
mutual fund (which invests only in sharia-compliant equities),
was created in Indiana.
• In 1990, the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) was created to establish
industry accounting and auditing standards.
• Also in 1990, the Islamic bond market emerged when the first
tradable sukuk — the Islamic alternative to conventional
bonds — were issued by Shell MDS in Malaysia.

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• In 1996, Citibank began to offer Islamic banking services

when it established the Citi Islamic Investment Bank in
Bahrain.
• In 1999, the Dow Jones Islamic Market Index (DJIMI) was
established, becoming the first successful benchmark for the
performance of Islamic investment funds.
• In 2002, the Malaysia-based Islamic Financial Services Board
(IFSB) was established as an international standard-setting
body for Islamic financial institutions.
• In 2004, the Islamic Bank of Britain became the first Islamic
commercial bank established outside the Muslim world.
In total, more than 500 Islamic financial institutions have been
established worldwide since the 1970s, including about 300 Islamic
banks. In the past two decades, the Islamic finance industry has
averaged growth of 14 percent per year, and its assets are
estimated to be worth $1 trillion. Islamic financial institutions are
currently operating in 75 Muslim and non-Muslim countries.

HOW IS ISLAMIC FINANCE DIFFERENT

FROM CONVENTIONAL FINANCE?
Islam is more than a religion; it’s also a code of life that deals with
social, economic, and political matters. Every Muslim is expected to
live according to the Islamic code, or sharia. Each issue addressed
by sharia is entwined with all other issues; therefore, economic
matters are related to religion, culture, ethics, and politics.

Islamic finance, then, is a financial system that operates according

to sharia. Just like conventional financial systems, Islamic finance

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features banks, capital markets, fund managers, investment firms,

and insurance companies. However, these entities are governed
both by Islamic laws and by the finance industry rules and
regulations that apply to their conventional counterparts.

A core concept of Islam is that Allah is the owner of all wealth in the
world, and humans are merely its trustees. Therefore, humans need
to manage wealth according to Allah’s commands, which promote
justice and prohibit certain activities. At the same time, Muslims
have the right to enjoy whatever wealth they acquire and spend in
sharia-compliant ways; they don’t need to feel shame about being
wealthy as long as their behavior aligns with Islam.

A Muslim believes that Islam does not restrict economic activity but
instead directsit toward responsible activity that benefits other
people, protects the earth, and honors Allah. In other words, Islam
allows for a free-market economy where supply and demand are
decided in the market — not dictated by a government. But at the
same time, Islam directs the function of the mechanism by imposing
specific laws and ethics.

A key purpose for imposing these laws and ethics is to promote

social justice; Islam and social justice are inseparable, and it’s a key
concept of the Islamic finance industry. Islam tries to achieve social
justice in the economy in many ways:

• Promoting adherence to Islam: A Muslim is expected to

adhere to certain core beliefs and perform certain obligatory
acts. By reminding Muslims of their obligations, Islam seeks to
promote stronger relationships between each person and
Allah, between people and the earth, and among individuals.

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• Requiring zakat: To promote justice related to the distribution

of wealth, Islam imposes a property tax called zakat. Every
Muslim who meets certain criteria regarding the accumulation
of wealth must pay zakat, which is distributed to people in
need. By taxing the property of people who acquire wealth and
distributing that tax to people in need, Islam promotes the
socially responsible distribution of wealth.

Zakat management is part of the Islamic finance field, and

zakat calculation is a separate, specialized field of study.

• Defining the state’s obligations: Per Islam, the state is also

responsible for ensuring that social justice exists. Islamic
scholars argue that the state should collect zakat and guide
wealth distribution to make sure that everyone’s basic needs
are provided for. Scholars also generally agree that states
should protect the real value of money by implementing sound
fiscal policy.

• Prohibiting usury (interest): For the sake of social justice,

Islam prohibits interest-based transactions. No individual or
business entity should hoard money in order to earn interest
(or riba); instead, that money should be used to support
productive economic activities.

• Encouraging shared risk: Islam encourages risk-sharing in

economic transactions. When a risk is shared among two or
more parties, the burden of the risk faced by each party is
reduced.

• Avoiding gambling: Two Arabic words refer to transactions

that involve gambling:
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o Maysir: The acquisition of wealth by chance and not by

effort

o Qimar: In modern gambling, any game of chance.

Both types of transactions are prohibited because they’re

based on uncertainty (gharar).

The Islamic prohibition against transactions that involve

gambling prevents Muslims from purchasing conventional
insurance products because those products are a gamble.
Instead, Islamic insurance, called takaful, is based on a very
different model of risk management that involves shared risk
and mutual responsibility.

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Literature Review
1.Kader & Asarpota (2007): applied financial ratio analysis to
assess the performance of the Malaysian Islamic bank and UAE
Islamic banks respectively. Similarly, to measure efficiency of
Islamic banks in Bangladesh, Sarkar (1999) utilized banking
efficiency model and claimed that Islamic banks can stay alive even
within a traditional banking architecture in which Profit-and-Loss
Sharing (PLS) modes of financing are less dominated. Sarkar
(1999) further claimed that Islamic financial products have different
risk characteristics and consequently different prudential regulations
should be in place.
2.Aggarwal and Yousaf (2000):In 1963, Islamic banking
came into existence on an experiment basis on a small scale in a
small town of Egypt. The success of this experiment opened the
doors for a separate and distinct market for Islamic banking and
finance and as a result, in 1970s Islamic banking came into
existence at a moderate scale and a number of full-fledge Islamic
banks was introduced in Arabic and Asian countries. Most of these
Islamic banks were in Islamic countries. Having started on a small
scale, Islamic banks and non-banking financial institutions are now
operation even on more intensive scale. Today, Islamic banks are
operating in more than sixty countries with assets base of over
$166 billion and a marked annual growth rate of 10%-15%. In the
credit market, market share of Islamic banks in Muslim countries
has risen from 2% in the late 1970s to about 15% today. These
facts and figures certify that Islamic banking is viable and efficient
as the conventional banking.
3.Chapra and Khan: highlighted the need to establish an
institution that would help to set regulatory standards and a
framework for supervision of Islamic financial institutions. They also
stated that there is a need to train Islamic bank regulators and 21
supervisors for developing effective internal rating and control
systems and risk management culture which will in turn improve the
external rating of these banks and help them not only in utilizing
their equity capital more efficiently but also in enhancing their

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growth and stability. They further discussed some of the crucial

juridical issues that need to be resolved to facilitate the effective
supervision of Islamic banks and accelerate their development. It
also highlights the facilities that need to be provided to help them to
overcome a number of the difficulties they are facing.

REFERENCES:
1. https://www.dummies.com
2. http://shodhganga.inflibnet.ac.in

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