Sunday, December 20, 2015

Module Name: Islamic Financial Management


OPEN UNIVERSITY MALAYSIA
FACULTY OF BUSINESS MANAGEMENT
BMIF5103
Islamic Financial Management
Master of Business Administration

Name: Adam Khaleel

Lecturer: Hassan Kalaam
Learning Centre: Villa College


Trimester:  September 2015


Contents

1.0 Question – 1

1.1 Introduction
The Islamic financial system (IFS) consist of stock market, banking sector and market for securitized assets. The banking sector have sub-sector which involves in high-credit and short-maturity securities to finance trade or commodities on the basis of murabaha to support the payment system. This would be similar to the concept of narrow banking which has been suggested in the conventional system. Islamic system claim that a financial system is based on the Islamic framework of risk sharing would be more efficient in allocating resources than a conventional interest-based system. The general argument underlying the proposition that the Islamic financial system is more stable that the conventional system is based on three notions: 1) the avoidance of leverage and debt refinancing due to the prohibition of debt; 2) the matching of assets and stabilities; and 3) the elimination of the multiplier effect (Prof. Rajola, 2012).
1.2 Absence of Leverage and Debt Refinancing
In Islamic financial system leverage is absent because of the constrained debt carrying power of economic units in the system and the inability to refinance positions in assets by creating additional debt along with the non-existence of interest rates. In conventional interest based system, the financing of investments and the ownership of capital assets as well as of consumer spending is carried out mainly through borrowing and lending. In this system money receipts includes the various commitments to make payments on existing debt. The liabilities on the books are the result of past financing positions that are taken on the basis of various margins of safety which is an excess of anticipated receipts over payment commitments (Iqbal & Mirakhor, 2011).
Firstly, a given economic unit in every period of its operation will have cash flows from its participation in income generation which will exceed contractual payments on remaining debt. Secondly it may place an economic unit in a position in which, in the short term, payment commitments exceed their corresponding cash flows, although the total expected cash flows exceed the total payments on outstanding debt and the net income position of the short-term cash flows exceeds the short-term interest payments on debts (Iqbal & Mirakhor, 2011).
Lastly, a situation may arise in which the short-term payment commitments exceed the expected cash flows and the short-term interest payments on outstanding debt exceed the income components of the short-term cash flows. In that interest-based system, there is a tendency on the part of the economic units to assume the last two types of financial postures, in which economic units can fulfill their payment commitments on debt only. Since the appreciation of an asset constitutes a portion of returns on that asset, the tendency is to refinance. For refinancing, the amount that the second type of unit needs to borrow is less than the maturing debt of the third type of unit and the latter will only be able to meet its payment commitments by increasing its outstanding debt (Iqbal & Mirakhor, 2011).
The last two types of unit engage in speculative financing meaning that, when the need arises to refinance, the refinancing of their maturing debts will be available at non-punitive interest rates. The feasibility of the third type of unit will depend on the assumption that some assets will be sold at high enough prices in future. Both the second and third types can have interest-rate fluctuations, since these units finance a long position in assets by issuing short-term liabilities. So that their viability depends on the price and the extent of the availability of refinancing. Also, there is a high probability of present value reversal for these units at higher interest rates, since higher interest rates lower the value of all cash receipts but this decrease is greater for more distant receipts (Iqbal & Mirakhor, 2011).
The high and fast rising interest rates increase financing activities in which investment activities depend on an increase in total short-term debt outstanding. This is because the interest payments that are due on earlier borrowings exceed the income earned by the assets. When the short-term debt that leads to a capitalization of interest increases relative to the gross capital income, there is an increase in demand for short-term financing. This increased need to rely on maturing debt not only shifts the demand curve for short-term debt to the right but also makes the curve less elastic (Iqbal & Mirakhor, 2011).
Rising short-term interest rates with increasing long-term interest rates will reduce the demand for capital assets and will also increase the cost of production, hence which leads to a decrease in investment. If there is falling asset values, rising carrying costs for asset holdings and decreasing profits will increase the probability of illiquidity and insolvency for a large number of firms. Hence the participants in the market may not be willing to refinance the maturing debts of these institutions. Therefore any given system of financial institutions, the lesser the weight of debt refinancing, the greater the stability of the system (Iqbal & Mirakhor, 2011).
1.3 Inherent Matching of Assets and Liabilities
The banks in conventional interest based system is exposed to asset and liability mismatches which will result instability in several financial crises. As a result this will expose the banks to illiquidity, meaning that the liabilities mature faster than their assets. In order to handle this illiquidity the banks have three options. The first one is the problem of liquidity is not a problem of maturity structure which means, if one bank can receive help from another bank when needed, assets can be shifted to other banks before maturity as the need arises. The second option is for a bank to increase interest rates in order to attract greater deposits to engage in liability management and to solve the problem of liquidity. If the short-term stock of total deposits is fixed, these two options can spread the problem of illiquidity. The danger is that all banks can become illiquid and cannot be met except by using the next option which is debt monetization. In this option, the banks must sell their slow maturing assets to the central bank in order to raise cash to meet fast maturing liabilities (Iqbal & Mirakhor, 2011).
The Islamic financial system is more stable because of an inherent matching of assets and liabilities because the structure of the assets and liabilities of the economic units are closely matched through profit sharing arrangements. The liabilities of each economic unit include equities and are fully amortized with future income flow. The payment of firms and financial institutions are in the form of dividends that will have to be paid only if profits are received. Meantime no debt refinancing can take place on an interest basis and if there is any refinancing it must be on the basis of sharing of future income expected from assets. In an Islamic system, the danger of insolvency arises only when their revenues fall short of their out of pocket costs and commitments. This situation can only occur either as a result of poor management or unnecessary economic factors but it is not inherent in the Islamic financial system (Iqbal & Mirakhor, 2011).
1.4 No Credit - Multiplier Effect
The stability of Islamic banking system was investigated using a formal mathematical approach by Khan. This model assumes an Islamic banking is structured in accordance with the “two - windows” model. In it the banks accept deposits on the basis of profit or loss as if they are equity where the nominal value of shares is not guaranteed and the rate of return is variable. This model shows the stability in response to certain types of shocks. In this model, it demands deposits have a 100% reserve requirement. Meantime investment deposit carries no guarantees but which has desirable safety benefits (Iqbal & Mirakhor, 2011).
Islamic finance is a two tier system which is a 100% money and an investment banking system. There is no money creation in a system with 100% reserve banking. Therefore the credit multiplier is zero for such a system. The investment banking will accept savings in the form of deposit and invest it buy equity shares. Hence, there is no creation of money through credit and investment will be fully financed by saving. The amount of deposits in the investment branch will be determined by real savings and the savings-to-income ratio but not by the credit multiplier. So that, there is a wealth creation but not money creation in a conventional system (Iqbal & Mirakhor, 2011).
The process of saving and income creation can be explained by the following example. For instance, suppose an Islamic investment bank accepts deposit of savings of MVR200. The bank invests this in the form of equity shares and the firms use this capital to buy machinery to expand their production capacity. The recipients of the MVR200, as a result of trading the products are assumed to save on average a certain percentage of their income. Suppose let it be 10%. Hence, they deposit new savings of MVR20 at the Islamic investment bank. The latter purchases equity shares for MVR20 and recipient firms invest the new capital. The recipients of the MVR20 as proceeds of trading will save on average 10% of their income which is MVR2. It can be shown that the process of income and savings generation increases the initial MVR200 of savings into MVR222. The savings multiplier can be expressed as 1/(1 − s) (Iqbal & Mirakhor, 2011).
So, the growth of financing activity will be stable and determined by real growth in the economy but not by unstable speculative money creation by financial institutions. Thus, an Islamic system would not be expected to experience deep boom and bust cycles. Moderate booms or recession can be generated by favorable climatic conditions or natural disasters by productivity and technical change or by real shocks. It is understood that if demand deposits are financed by a 100% reserve requirement, the features of fractional-reserve banking will be eliminated. The explanation for a 100% reserve requirement based on property but all Muslim scholars are not convinced of the necessity of a 100% reserve requirement. The supporters of the two tier mudarabah model argue that a fractional-reserve system fully guaranteed by a debt issuance scheme (Iqbal & Mirakhor, 2011).
1.5 Conclusion
We should note that the social and human costs of financial instability and financial crises are found in conventional system. The human cost of prolonged unemployment and its impact on the individual psyche and on families are major issues. The impact on individual regions is much more extreme than average effects. The unfair redistribution of wealth, at the expense of individuals on fixed incomes and creditors is simply immoral. However, in an Islamic system, banks-in accordance with Allah's command-have to prohibit interest and speculation and engage directly in trade and investment operations. In an Islamic system, unbacked expansion of credit is preempted, and banks cannot initiate and accentuate a speculative process. Credit is based on real savings. Money flows arise from sales of goods and services and transit through the banking system for payments or investment purposes. Islamic banks do not compete to issue loans to borrowers for liability management purposes arising from mismatched maturities between assets and liabilities.

2.0 Question - 2

2.1 Introduction
Although Islamic commercial banks have many products similar to those offered by conventional banks, the two entities differ conceptually in several ways such as Nature of fiduciary responsibilities, Profit/loss sharing, enhanced monitoring, Asset/liability management and Presence of Shariah boards. These differences are explained below;
2.2 Nature of Fiduciary Responsibilities
Agency theory has generated in financial economics including Islamic banking system. In an agency relationship is between the principal the agent to perform some actions on the principal’s behalf. In this contract the agent has the decision making authority. Agency relationships are found in all parts of the world. For example, agency relationships exist between firms and their employees, between banks and borrowers and between shareholders and managers. The agency model of the firm shows that conflict between principal and agent or agency conflict which is found in the modern corporation. This is because the decision making and risk taking functions of the firm are carried out by different individuals. The model says that managers tend to involve in excessive advantage and other conflicting behavior because they receive the full benefit from these acts. The agency cost of equity can be minimized by increasing the manager’s role in the ownership of the firm. In the principal-agent approach acts as the incentive for the agent and forcing managers to bear more of the wealth. As a result their actions is a better contract for the shareholders (Iqbal & Mirakhor, 2011).
The agency theory can be applied to profit or loss sharing instruments like mudarabah. The model that is found under a mudarabah contract shows the managerial effort which picks up the role of regulating the contract. A standard incentive is compatible interest based contract so that the manager is free to choose the individually optimal level of effort in each investment. However, in mudarabah an explicit mapping between the remuneration of capital and the outcome of the project is created. A mudarabah lets the contract to control directly the manager’s incentive to use effort because this effort affects the relationship between capital investment and the outcome of the project. In a mudarabah contract the manager is free to choose the individually optimal level of investment in each state of the economy. Presley and Session’s model says that these individually optimal levels match to the full information and productively efficient levels such that a mean variance improvement in capital investment can be achieved (Iqbal & Mirakhor, 2011).
In financial intermediation of Islam, they simply “passes through” the performance of its assets to the investors or depositors on the liability side. There is also an element of risk sharing which is present in the contractual agreement between the financial intermediary and the depositor or investors. The assets in the balance sheet could be in the form of over the counter assets financed by the Islamic bank or direct investments in marketable securities of Shari’ah compliant assets which are equities or asset linked securities. There is a greater diversity of contractual agreements in Islamic banks because the bank may be acting as a trustee in one mode of intermediation and as a partner in another. The bank also enters into a principal-agent model on both sides of the balance sheet. The purpose of showing different contractual agreements is to show that Islamic banks have more fiduciary responsibilities in which they have a direct impact on the governance of the financial institution (Iqbal & Mirakhor, 2011).
2.3 Profit/Loss Sharing
The profit or loss sharing concept shows a direct concern for the profitability of the physical investment on the part of the Islamic bank. The conventional bank is also concerned about the profitability of the project because of issues about potential default on the loan. But the conventional bank puts the emphasis on receiving the interest payments according to set time intervals. As long as this condition is met the bank’s own profitability is not directly affected even if the project has high or low rate of return. On the other hand, the Islamic bank has to focus on the return on the physical investment this is because its own profitability is directly linked to the real rate of return (Iqbal & Mirakhor, 2011).
The direct relations between payment to the creditor and profitability of the project is very important to the entrepreneur. The most important thing is, profit-sharing contracts have superior properties in the area of risk management this is because the payment by entrepreneur has to make to the creditor is decreased in economic downturn. Moreover, if the entrepreneur experiences short-term debt-servicing difficulties in the interest based system, like short-term adverse demand shock, there is the risk of a magnification effect. This means that the credit channels might dry up because of lenders overreacting to the bad news. This might be due to the fact that the bank’s profitability is not affected by the fluctuating fortunes of the customer’s investment, except when there is a change of regular interest payments to a default problem (Iqbal & Mirakhor, 2011).
The interest payments are due regardless of the profitability of the physical investment. Also the conventional bank experiences a change in its profitability only when there are debt servicing difficulties. But a temporary cash flow problem for the entrepreneur and few delayed payments might be seen due to a regime change and this could blow up into a “sudden stop” in lending. On the other hand, in Islamic model, these temporary shocks would generate a different response from the bank because the lenders receive information on the ups and downs of the client’s business regularly which provides the important advantage that the flow of information (Iqbal & Mirakhor, 2011).
2.4 Enhanced Monitoring
The Islamic financial contracts encourages banks to focus on the long term in their relationships with their customers. But there might be higher costs in some areas in this long term relationships of profit or loss-sharing arrangements, mainly with regard to the need for monitoring the performance of the entrepreneur. Conventional banks are not necessarily needed to oversee projects as closely as Islamic banks because the former do not act as if they were partners in the physical investment. The Islamic banks provide something similar to equity financing as against debt financing, they need to invest more in managerial skills and expertise to oversee different investment projects. This is a reason why there is a tendency between Islamic banks to depend on financial instruments that are allowed under Islamic principles but may not have the best risk sharing properties. This is because in some respects they are closer to debt than to equity (Iqbal & Mirakhor, 2011).
2.5 Asset/Liability Management
Islamic banks provide the asset portfolios in the form of risky open ended “mutual funds” to investors. On the other hand conventional banking system provide the assets through issuing time-bound deposit contracts. As a result of this practice results in solvency and liquidity risks because the asset portfolios and loans involve risky payoffs or liquidation costs prior to maturity, when the deposit contracts are liabilities that are often payable promptly at par value. However Islamic banks act as agents for investors or depositors. Therefore it creates a pass through intermediation between savers and entrepreneurs by eliminating the risks faced by their conventional counterparts (Iqbal & Mirakhor, 2011).
The most different and critical features of financial intermediation by Islamic banks is the inherent design in which the assets and liabilities sides of the Islamic bank’s balance sheet are matched but in conventional bank, the deposits are accepted at a preset rate regardless of the rate of return earned on the bank’s assets side. This will create a fixed liability without any certainty that the bank will be able to earn more than it assured or was committed to paying to the depositors. As the return on the asset depends on the bank’s capability to invest the funds at a higher rate than the one assured on the liability side and this rate is unknown, which will lead to the problem of mismatch between assets and liabilities (Iqbal & Mirakhor, 2011).
As there is no preset rate on the assets side of the Islamic bank, the asset-liability mismatch will not arise. It is argued that because of the pass through nature of the business and the close matching of assets and liabilities, the financial intermediation by Islamic banks helps to stable the financial system (Iqbal & Mirakhor, 2011).
2.6 Presence of Shari’ah Boards
The major different features of Islamic banking is the existence of a Shari’ah board that includes religious scholars and the influence this board exerts on the operations of the bank. Islamic banks should not introduce a new product without the prior permission and approval of the Islamic Shari’ah board and depending on the affiliation of the religious scholars on the board to any particular school of jurisprudence because this can determine the success or failure of a product with its target clients. Many of these scholars sit on a number of boards, so that each institution may claim strong endorsement to enhance the credibility of its practices. The presence of Shari’ah boards can provide satisfaction to the depositors because the board will monitor the institution’s compliance with Shari’ah principles (Iqbal & Mirakhor, 2011).
2.7 Conclusion
Therefore, these differences make the Islamic and conventional systems totally different from each other. The two systems operate in the same environment but with different modes of operation and opposite objectives.

3.0 Question - 3

3.1 Introduction:
Capitalism, Communism and Mixed Economics system has purely a materialistic approach in which human social life has no importance. But in Islamic System, the followers of Islam are required to lead a material life in such way that it becomes a source of happiness and respect of others in this world for making secure himself for next world. Islamic Economic System consist of institutions, organizations and the social values by which natural, human and manmade resources are used to produce, exchange, distribute and consume wealth. Goods and services under the guiding principles of Islam to achieve “FALAH” in this world and hereafter. The objective of the Islamic economic system, like any other economic system, is the realization of efficiency and equity in allocation and distribution of resources, for which it recognizes the role of market forces and the freedom of individuals. But it also recognizes the possible adverse impact of the totally unregulated market on various sections of society, particularly the poor and the disadvantaged (Ayub, 2007).
3.2 Main Sources
The fundamental sources of Islam are the Quran and the Sunnah of the Prophet which provide guidelines for economic behavior and a blueprint of how the economic system of a society should be organized. The expansion of the regulative rules of the Shariah and their extensions to new situations in later times was accomplished with the aid of consensus of the scholars, analogical reasoning which derived rules by discerning an analogy between new problems and those existing in the primary sources and finally, through textual reasoning of scholars specialized in the Shariah. Therefore, the values and objectives of all “Islamic” economic systems must necessarily conform to, and comply with, the principles derived from these fundamental sources (Ayub, 2007).
3.3 Main characteristics (elements) of Economic System of Islam are:
1. The Concept of Private Property:
Basic Principles in Islam for Consumption or Investment of private property are: all resources in the world belong to its Allah; human beings are holding these resources in rust. Concept of “HALAL” and “HARAM” for earning or in production and consumption of wealth. A property cannot be used against public interest. One should show much as he have something. Real or money Capital cannot be used for gain and payment of Zakat is compulsory (Dr. Chaudhry, 2015).
2. Consumption of Wealth:
In Islamic System uses of luxuries are not allowed because it against the concept of “TAQWA” should have distinguish between “I-IALAL” and “I-IARAM”, “BUKHAL” and “ISRAF’
are to be avoided. Prohibited goods cannot be consumed, consumption cannot be extravagant, consumption should lead to an efficient and pure life and every individual should consume enough goods to lead a reasonable life (Dr. Chaudhry, 2015).
3. Production of Wealth:
Price mechanism plays a key role in carrying out the production process in an Islamic
Society. As Price system results in the expectations of workers and consumers the Government
Interferences with the price mechanism to overcome the problem. Things that are not
allowed in Islamic System include production of drugs, gambling, lottery, music, dance etc. In addition to this lending and borrowing on interest; black marketing, smuggling etc. are prohibited (Dr. Chaudhry, 2015).
4. Distribution of Wealth:
Islamic Economics System favour fair distribution of wealth in the sense
that it should not be confined to any particular section of the society. For fair distribution of
wealth Islam gives following steps: “BUKHAL” and “ISRAF” are to be avoided. Payment of Zakat. Interest is not allowed. Monopoly of Private firm not allowed. Earning from Black Market is not allowed (Dr. Chaudhry, 2015).
5. The Concept of Zakat:
Zakat is a major source of revenue the government in an Islamic state. It levy on all
goods and money or on wealth if have to pay yearly. Zakat is obligatory after a time span of one lunar year (approximately 355 days) passes with the money in the control of its owner. Then the owner needs to pay 2.5% (or 1/40) of the money as Zakat. The owner should deduct any amount of money he or she borrowed from others (Dr. Chaudhry, 2015).
6. Interest free Economy:
The abolition of all interest based contracts, to be replaced by contracts which share returns and risks. Allah (swt) says: “Allah has permitted trade and forbidden (all) interest.” [TMQ Al-Baqarah: 275]. The whole financial system the bank structure in particular is run on the basis “SHARAKAT” and “MUZARABAT” in Islamic state. Therefore, Islamic economics is an interest free economy.
7. Islam is against monopolies and encourages competition
PLC stock market companies are able to amass huge amounts of wealth today, to the extent that some companies have more wealth than some countries. In an Islamic system this could not happen due to the prohibition of PLC’s who are able to generate this wealth by issuing shares to the public. This has a positive impact on the economy, as huge companies are able to become monopolies, duopolies or oligopolies which are able to dominate the market place. The Islamic economic system leads to this as by applying its rules it would lead to small to medium companies competing with each other in every market which is healthy for the economy as competition decreases the price and increases quality (The economic system of Islam, 2013).
8. Responsibility of the Government:
Responsibility of the Islamic Government include: should check un-Islamic activity like gambling, smuggling, black marketing etc. Should secure poor people by giving them necessity of life i.e. food, clothing, health etc. Should provide equal employment opportunity. Social and Economic Security is required to guarantee by the Government (Dr. Chaudhry, 2015).
9. Contractual agreements:
Compliance with Islamic principles is the basis of all contracts between parties performing some specified act in exchange for a lawful consideration and the most important building block for an Islamic financial and economic system. Therefore a thorough understanding is required of the Shari'ah-acceptable contracts in their multifarious and varied forms that could be used to design and develop Shari'ah-based financial products and to provide Shari'ah-compliant financial solutions. Musharakah, mudarabah, murabahaand ijarah contract types form the basis of a variety of Shari'ah compliant alternatives to conventional interest-based financing solutions (Dr. Chaudhry, 2015).
10. Trust:
Trust, and being worthy of another’s trust, is inherent in being one who is submitted to the will of God.  When God appointed Adam (the father of mankind) as successor on earth, it was a trust incumbent upon all of mankind.  When God created us as individuals for worshipping Him, it became a trust incumbent upon us to nourish ourselves and our families in a way that enables worship. In Islam, every believer is a brother or sister to the other; we are one body, one nation.  The right hand must be able to trust the left hand.  The commands and rules from God are designed for our benefit and Islam holds people’s rights in high esteem.  The systematic arrangement of guidelines and regulations is intended to uphold the rights Islam gives to the believers and to minimize vice and corruption.  Islam strongly condemns the violation of God-given rights.  When God commands us to keep the trust, to be trustworthy, it is not a matter to be taken lightly (Dr. Chaudhry, 2015).
11. Risk Sharing:
While Islam employs various practices that do not involve charging or paying interest, the Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilising the funds at risk on a profit-and- loss-sharing basis. Such participatory modes used by Islamic banks are known as Musharakah and Mudarabah. This by no means implies that investments with financial institutions are necessarily speculative. This can be excluded by careful investment policy, diversification of risk and prudent management by Islamic financial institutions (Dr. Chaudhry, 2015).
12. Market Conduct:
Islam has never developed a separate theory of political or moral economy in the way that economic science and analysis have evolved in the western tradition. Islamic economics are embedded in the broader framework of the jurisprudence of transactions and in the scholasticism of the moral philosophers of Islam. The Sharia did not leave much room for economics. Wherever the issues of prosperity of the community or welfare of the common person were discussed, this was part of the same tradition of exhortatory writings to the ruler about the value of a sound currency, about fairness in dealings and about the risks of punitive taxation. Otherwise it was assumed that people were ordained to conduct their business affairs and transactions within the bounds of the Sharia and its detailed norms concerning the permissible and the lawful in economic conduct and behavior (Dr. Chaudhry, 2015).
3.5 Conclusion
As one can immediately surmise from these principles that the Islamic economic system is radically different from others, due to the difference of the values upon which it is based. In a capitalist society, one may see certain rules of economics which take precedence over moral and ethical values due to the intrinsic nature and values of that system. The same may be seen in communist, socialist and other societies as well. The Islamic economic system is neither Capitalist where the market is left free to lead to the disasters that we are seeing nor Communist where everything is owned and controlled by the state. Islam distinguishes between public property, state property and private property. Islam forbids the private ownership of the large resources such as the Oil and Gas that we see the Western companies fighting over in the Muslim world. Therefore in order to improve the capitalism and communism, the Islamic principles found in Islamic economic system should be considered.

4.0 Question - 4

4.1 Introduction:
A nonbank financial institution (NBFI) is a financial institution that does not have a full banking license and cannot accept deposits from the public. However, NBFIs do facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission, and check cashing. Non-Banking Financial Institutions (NBFIs) is also play an important role in economy. NBFIs also providing financial services on wide range. NBFIs work to offer enhanced equity and risk-based products. The NBFIs provide medium to long-term finance to different sectors of the economy. Among the specialized sector finance companies that currently in existence are as follows.
4.2 Islamic Mortgage Companies
Islamic mortgage companies provide home buyers with Shari’ah compliant options to purchase property. They normally target Muslim communities in Western countries with developed conventional mortgage markets like Canada, the United Kingdom and the United States. There are four major models of Islamic mortgage in practice. They are as follows: (Iqbal & Mirakhor, 2011).
(a). Lease to Own: The first model is based on the ijarah wa “qtinah” (lease to own) contract. In this contract the mortgage company buys the desired property from the builder, rents or leases it to the home buyer for a specific period of time. After that it is sold to the home buyer for a preset residual value. This is similar to conventional mortgage (Iqbal & Mirakhor, 2011).
(b). Cost Plus Mark – up: This model is based on the murabahah contract in which the bank purchases the desired property from the owner and sells it to the new home buyer at cost plus a preset profit. The buyer and bank enter into an agreement where the buyer agrees to pay the financed amount over a preset period in pre agreed installments. This is similar to the conventional fixed-rate mortgage (Iqbal & Mirakhor, 2011).
(c). Diminishing Partnership: This model is based on the musharakah (equity partnership) where the financier and the buyer form an equity partnership to jointly own the property and the financier gives the buyer the option to buy the financier’s share over the life of the mortgage. During this period, the buyer pays monthly installments including the property’s monthly rent and the additional contribution to buy out the mortgagee’s share (Iqbal & Mirakhor, 2011).
(d). Cooperative Model: This model is similar to a cooperative set up. Members will buy equity membership in a pool of funds used to purchase properties for the members (Iqbal & Mirakhor, 2011).
4.3 Mudarabah Companies
The mudarabah company specializes in financing a portfolio of assets in selected economic sectors by using its own capital and investors’ funds and they are mobilized by issuing shares on a profit and loss basis. This contract can be used for multi-purpose and specific purpose transactions. These contracts are independent of one another and no transaction is liable for the liabilities of any other mudarabah transaction (Iqbal & Mirakhor, 2011).
These companies are specialized in leasing and are therefore also a valuable source of funding for small and medium sized enterprises for trade and fixed assets. However the regulatory mismanagement and lack of rigorous screening of company listings have also resulted in losses to investors. This outcome has discouraged other countries from experimenting with mudarabah companies (Iqbal & Mirakhor, 2011).
As a profit or loss-sharing commitment, a mudarabah gives preference to financially sound business ventures over ordinary ones. Therefore helping to enhance resource management. Mudarabah companies can help for economic growth in Islamic economies it is administered properly. The regulatory agencies must perform diligent screening and controls and require to increase investor confidence. Mudarabah companies can help to enhance transparency and operational efficiency (Iqbal & Mirakhor, 2011).
4.4 Specialized Leasing Companies
The Islamic leasing is normally used for real estate and automobiles. Leasing company use an ijarah contract in which the ownership of the asset, associated risk and responsibility for its maintenance remains with the leasing company. The company is not the original owner of the asset but obtains it at the request of the customer. At the end of leasing period, the institution can sell the asset to the client. Some companies for the leasing of equipment use murabahah in which the ownership of the asset is transferred to the lessee and the leasing company does not have any rights to sell or transfer the asset (Iqbal & Mirakhor, 2011).
Leasing allows businesses to have capital goods without purchasing them. Hence it can promote economic stimulation. At the same time it provides the leasing company with an attractive flow of fixed monthly income. Islamic forms of leasing are similar to those of interest based models. Islamic leasing companies have huge potential to beat both markets. The main concern which leasing companies must deal with is developing liquidity for leased assets as a result of leasing. Lease securitization can have a leading role to enhance the liquidity of these companies with proper management (Iqbal & Mirakhor, 2011).
4.5 Microfinance Institutions
Microfinance is a type of group lending. In it no collateral is required and only the poor could borrow but each customer need to be a member of a five person group. The loans are granted to individuals within the group for their own independent projects and if they are failed to repay the loan would lead to collective punishment. As a result the entire five-member group would lose its membership in the bank. The interest rates of microfinance banks have been in the order of 20 to 30 percent (Iqbal & Mirakhor, 2011).
The Microfinance and Islamic finance share common ideas and values. In Islam it is emphasis on economic and social justice through financial inclusion and risk sharing is the foundation for Islamic microfinance. The Islamic finance is established itself and attempts have been made to establish Shari’ah compliant microfinance. Current Islamic microfinance lending has straggled the advance of the conventional microfinance movement. Today the institutions that have entered the market to service the demand of poor Muslims refuse to provide financing instruments that contravene Shari’ah principles. The types of microfinance include; (Iqbal & Mirakhor, 2011).
(a). NGO - based Microfinance: Microfinance NGOs follow the objectives of social and financial returns. They are concerned with providing financial services to those individuals who are too poor to offer sufficient collateral security to the bank. Many NGOs offer vocational training and advice on investment decision to their clients. But loans are not spent as charity. Islamic microfinance NGOs use murabahah as their primary product (Iqbal & Mirakhor, 2011).
(b). Islamic Microfinance Cooperatives: They are community based organizations designed to mobilize deposits from clients and use these funds to provide productive, consumer and social loans to their members (Iqbal & Mirakhor, 2011).
(c). Credit Union - style Microfinance: Credit Union is a non-profit financial cooperative which is owned and controlled by its members and engaged in mobilizing savings and offer loans to its members who have common objective (Iqbal & Mirakhor, 2011).
(d). Qard - ul - Hassan - based Microfinance: Qard - ul - Hassan funds are socially concerned organizations which provide community members the interest free loans. It is the only type of loan permitted under the Shari’ah. It is also considered a form of charity because the lender is encouraged to forgive (Iqbal & Mirakhor, 2011).
4.6 Takaful (Islamic Insurance)
Islamic instrument for the present system of insurance is the of takaful which means “joint guarantee.” Currently it has very limited application in Islamic financial markets with very few institutions offering insurance services. Even though application of takaful is for the most part indemnity based of physical property, there are products in the market targeting family and medical coverage based on Islamic Shari’ah (Iqbal & Mirakhor, 2011).
There is no specific standard operating model for takaful companies because each country decide on a particular model. Takaful models can be mudarabah based, wikala based or hybrid of the two models. Implementation of takaful is carried out in the form of mudarabah where the participants agree to share their losses by contributing premiums in the form of investments. They are then allowed to redeem the residual value of profits after getting the claims and premiums. The critical differences among insurance models and takaful is the member’s right to receive surplus profits. The members in takaful mudarabah have the right to share the surplus profits generated. Meantime they are liable for additional amounts if the initial premiums paid during a period are not sufficient (Non-Bank Financial Institutions, 2014).
In wikala model, policyholders and takaful operator enter into principal and agent agreement in which the operator becomes the representative of the principal. The operator gets an agreed fee to operate and manage the principal’s assets. In Hybrid model the wikala agreement is utilized for underwriting activities and to run the operation and at the same time mudarbah contract is used for asset management purposes. In this situation, the asset management business can be operated by a completely different entity (Iqbal & Mirakhor, 2011).
4.7 Distinctive Features of Takaful
(a). Cooperative Organization: Takaful is based on principles of mutual assistance and it is similar to conventional cooperative insurance (Iqbal & Mirakhor, 2011).
(b). Risk Sharing: Takaful is closer to the essence of Islamic finance than the Islamic banks. Policyholders share in the profits and losses of the business through sharing each other’s insurance risk as compared to conventional insurance and there is no sharing of risks across policyholders (Iqbal & Mirakhor, 2011).
(c). Shari’ah - compliant Investments: All investments and assets under management are invested in accordance with the principles of Islam and therefore have to be fully compliant with Shari’ah (Iqbal & Mirakhor, 2011).
(d). Mutual Guarantee: It is based on cooperative principles which spread the liability between the policyholders and all losses are shared (Iqbal & Mirakhor, 2011).
4.8 Conclusion
NBFCs are developing in last few decades with wide variety of products and services. There has been significant increase in such companies in the past decades. NBFCs collect public funds and provide loan able funds. Meantime they are playing a vital role in the development financial system of many countries.

5.0 References

Ayub, M. (2007). Understanding Islamic Finance. England: John Wiley & Sons Ltd.
Dr. Chaudhry, M., S. (2015). Fundamentals of Islamic economic system. Retrieved October 11,    2015, from http://www.shaufi.com/b16index.htm
Iqbal, Z & Mirakhor, A. (2011). An Introduction to Islamic Finance: Theory and Practice (2nd Ed.) Singapore: John Wiley & Sons Ltd.
Non-Bank Financial Institutions. (2014). Monetary Authority of Singapore. Retrieved October 11, 2015, from http://www.mas.gov.sg/statistics/monthly-statistical-bulletin/non-bank-financial-institutions.aspx
Shaban, M., Ali, Y., Bilal, M & Izhar, N. (2013). Difference Between Islamic Banking and Commercial Banking & Features of Islamic Economic System in Pakistan. Retrieved October 10, 2015, from http://www.slideshare.net/mutahirbilal47/difference-between-islamic-banking-and-commercial-banking-features-of-islamic-economic-system-in-pakistan
The economic system of Islam. (2013). Islamhouse.com. Retrieved October 11, 2015, from http://islamhouse.com/en/articles/429666/
Posted by at
Labels:

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.

Subscribe to: Post Comments (Atom)