What is Islamic Finance and how is it different from conventional finance?
What Is Islamic Finance?
Islamic finance is a form of finance based on Shariah or the body of Islamic law. Shariah, which means "the path to the water source", is filled with moral purpose and lessons on the truth and is more than just a set of legal rules. At its core, Shariah represents the idea that all human beings and governments are subject to justice under the law. It is a term that summarises a way of life prescribed by Allah for His servants, and it extends to everything from business contracts and marriage to punishment and worshipping. It is common to use "Shariah-compliant" to describe anything permissible under Islamic law.
On this page
- Benefits of Islamic finance
- Types of Islamic finance
- How is it different from conventional finance
- CIMA Diploma in Islamic Finance
Benefits of Islamic finance
Islamic finance has several potential benefits for individuals and the broader economy. Some of the potential benefits of Islamic finance include the following:
- Ethical investment: Islamic finance prohibits funding activities that are considered harmful or unethical, such as gambling or the production of tobacco or alcohol. This may make it attractive to investors looking for socially responsible investment options.
- Risk sharing: The profit and loss sharing structures used in Islamic finance may help to distribute risk more evenly between financial institutions and their customers, as both parties share in the risks and rewards of an investment.
- Financial inclusion: Islamic finance may be more accessible to specific groups of people, such as those who are opposed to charging interest on loans for religious reasons. This can promote financial inclusion and access to financial services.
- Economic development: By focusing on actual economic activity and tangible assets, Islamic finance may help to promote economic development and growth.
- Stability: The prohibition of excessive uncertainty and risk in Islamic finance may make it less prone to financial crises and other forms of instability.
Overall, the potential benefits of Islamic finance depend on the specific practices and structures used by individual financial institutions and may vary in different contexts.
Types of Islamic finance
There are several types of financing structures used in Islamic finance, which are based on the principles of sharia and seek to promote economic development and social justice per the values and teachings of Islam. Here are a few examples of common types of Islamic financing:
- Murabaha: This is a type of cost-plus financing in which a financial institution purchases a product on behalf of a customer and sells it to the customer at a marked-up price. The profit earned by the financial institution is the "markup" on the cost of the product.
- Ijara is a leasing arrangement in which a financial institution owns an asset and leases it to a customer for a specified period. The customer pays a lease rental to the financial institution, which may be based on a profit and loss sharing arrangement.
- Musharaka: This is a type of joint venture financing in which a financial institution and a customer enter into a partnership and share the profits and losses of a business venture.
- Mudaraba: This is a type of trust financing in which a financial institution provides capital to a customer to invest in a business venture. The customer manages the venture, and the financial institution receives a share of the profits while bearing no liability for any losses.
- Sukuk: This Islamic bond is a financial instrument based on tangible assets or productive economic activity. Sukuk are designed to comply with sharia and may be used to raise capital for various purposes.
These are just a few examples of Islamic financing used in practice. Many other structures and practices are used in Islamic finance, and the specific approach used may vary depending on the needs and goals of the financial institution and its customers.
How is Islamic finance different from conventional finance?
Unlike conventional finance, which most of us know, Islamic finance has one overarching requirement—every financial transaction must be Shariah-compliant. In ensuring Shariah compliance, five fundamental principles are strictly followed. Here are the key differences between Islamic Finance and Conventional Finance.
- Interest (riba) is prohibited in Islamic finance. Instead of charging interest, Islamic financial institutions may use profit and loss sharing arrangements or charge fees for services provided.
- Islamic finance emphasizes tangible assets and actual economic activity. Financial instruments must be based on tangible assets or productive economic activity and cannot be used to fund activities considered harmful or unethical.
- Islamic finance places a strong emphasis on social justice and ethical behaviour. Financial transactions must be fair and transparent and cannot involve uncertainty or speculation.
- Islamic finance may also incorporate principles of charity and philanthropy, focusing on shared responsibility and wealth distribution among community members.
- Islamic finance is governed by Islamic law (sharia), and its principles are based on the teachings of Islam. This may include the prohibition of certain types of financial products or practices that are considered contrary to the values and principles of Islam.
- Islamic finance prohibits using financial instruments that involve excessive uncertainty or risk, such as derivatives or certain types of insurance.
- Islamic finance may also involve establishing partnerships between financial institutions and their customers, in which both parties share the risks and rewards of an investment.
- Islamic finance often involves using specific financial products and structures designed to comply with sharia, such as musharaka (joint venture) and mudaraba (trust financing).
- Islamic finance may also place a greater emphasis on social and environmental considerations, focusing on sustainability and promoting environmentally friendly and socially responsible practices.
- Islamic finance may also be subject to additional regulatory requirements, as both sharia and traditional financial regulations govern it.
From where can we learn Islamic finance
To help fuel growth in Islamic finance and to help the industry meet its shortage of qualified professionals, CIMA's Diploma in Islamic finance qualifications are designed to appeal to both those who are entirely new to this area of finance and those who are fully experienced and are keen to develop their expertise to a higher level.
CIMA is a reputable professional organization that offers a range of financial and management accounting qualifications, including the CIMA Diploma in Islamic finance.
The CIMA Diploma in Islamic finance is a professional qualification designed to provide financial professionals with a comprehensive understanding of the principles and practices of Islamic finance. It covers a range of topics, including sharia principles, Islamic financial products and structures, and the regulatory environment for Islamic finance.
To earn the CIMA Diploma in Islamic finance, candidates must complete a series of exams and meet other requirements set by CIMA. Upon completing the program, candidates are awarded the CIMA Diploma in Islamic finance and may use the post-nominal letters "Dip.IF" after their name.
Overall, the CIMA Diploma in Islamic finance is a comprehensive and rigorous qualification designed to provide financial professionals with the knowledge and skills needed to work in the field of Islamic finance.
Eduyush is an authorized partner of CIMA, and if anyone is interested, they can avail of the course at attractive discounts. Interested students can browse the course here.
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