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ARTICLE CHOSEN - ISRA international Journal of Islamic Finance

Summary

Islamic finance refers to how businesses and individuals raise capital in accordance with Sharia, or Islamic law. It also refers to the types of investments that are permissible under this form of law. Islamic finance can be seen as a unique form of socially responsible investment. This subbranch of finance is a burgeoning field. In this article, we offer an overview to provide elementary information and serve as the basis for further study.

Basic Financing Arrangements

A brief overview of permissible financing arrangements often encountered in Islamic finance is given below.

Profit and Loss Sharing Contracts (Mudarabah)

The Islamic bank pools investors' money and assumes a share of the profits and losses. This process is agreed upon with the depositors. What does the bank invest in? A group of mutual funds screened for Sharia compliance has arisen. The filter parses company balance sheets to determine whether any sources of income to the corporation are prohibited. Companies holding too much debt or engaged in forbidden lines of business are excluded. In addition to actively managed mutual funds, passive funds exist as well. They are based on such indexes as the Dow Jones Islamic Market Index and the FTSE Global Islamic Index.

Declining Balance Shared Equity

Declining balance shared equity calls for the bank and the investor to purchase the home jointly. It is commonly used to finance a home purchase. The bank gradually transfers its equity in the house to the individual homeowner, whose payments constitute the homeowner's equity.

Lease to Own

This arrangement is similar to the declining balance one described above, except the financial institution puts up most, if not all, of the money for the house and agrees to sell the house to the eventual homeowner at the end of a fixed term. A portion of every payment goes toward the lease and the balance toward the home's purchase price.

Installment Sale (Murabaha)

An installment sale starts with an intermediary buying the home with a free and clear title to it. The intermediary investor then agrees on a sale price with the prospective buyer; this price includes some profit. The purchase may be made outright (lump sum) or through a series of deferred (installment) payments. This credit sale is an acceptable form of finance and is not to be confused with an interest-bearing loan.

Leasing (Ijarah)

Leasing, or Ijarah, involves selling the right to use an object (usufruct) for a specific time. One condition is that the lessor must own the leased object for the duration of the lease. A variation on the lease, 'ijarah wa 'iqtina, provides for a lease to be written where the lessor agrees to sell the leased object at the lease's end at a predetermined residual value. This promise binds only the lessor. The lessee is not obligated to purchase the item.

Islamic Forwards (Salam and Istisna)

These are rare forms of financing, used for certain types of business. These are an exception to gharar. The price for the item is prepaid, and the item is delivered at a definite point in the future. Because there is a host of conditions to be met to render such contracts valid, the help of an Islamic legal advisor is usually require

BRIEF CONCLUSION

Islamic finance is a centuries-old practice that is gaining recognition throughout the world. The ethical and economic principles of Islamic finance are even drawing interest outside the Muslim community. Given the increasing development of Muslim nations, expect this field to undergo even more rapid evolution. Islamic finance will continue to address the challenges of reconciling Islamic investment policy and modern portfolio theory.