How Islamic Finance Works

How Islamic Finance works?

Almir Colan | @almircolan | almir@auscif.com | www.AusCIF.com

AusCIF aims to:
»Raise the awareness of Islamic Finance by developing
comprehensive and unique educational programs and research
capabilities;
»Encourage and improve links between academics,
practitioners, government and community;
»Attract leading international Islamic finance scholars and
researchers in order to build lasting high-level international
linkages, global partnerships and contribute to the developments
of the Islamic banking and finance industry;
»Enhance Islamic finance research, practices and public
awareness via Islamic finance events and conferences; and
»Facilitate the development of local research programs in new
and emerging fields of Islamic banking and finance.

What
does
religion
have
to

do
with
wealth
and

economic
life?

Set
of
rules
=
Shari’ah

(Prohibi=ons,
obliga=ons,

clariﬁca=ons
and
so
on)

!

Islam
= 

“way
of
life”
(Qur’an
5:3)

Objec=ves
of
Shariah

Preserving:

1.
2.
3.
4.
5.

Ibadaat

(Acts
of
Worship)

Religion

Life

Family
Progeny

Wealth

Intellect
and
honor

Muamalaat

(Interac=ons
with
People)
v Islamic
ﬁnance,
economy…

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facebook.com/Islamic.Finance.Au

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Money &
wealth?

Story of Yusuf a.s.; Shu’ayb a.s. (Madyan)

1 (out of 5) of the Maqasid (aims) of sharia is
preservation of wealth. (other: Religion, Life,
Family Progeny and Intellect/honor)

1 (out 4) questions on Day of Judgment is
about wealth: “where he earned it and how he
spent it.” (other: life, knowledge, body)
(Tirmidhi)

Riba: “a war [against you] from Allah and His
Messenger.” (Qur’an, 2:279)

Zekat and Hajj (2/5 pillars of Islam) directly
linked with your ﬁnancial ability.

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“A
#me
will
come
when
one
will
not

care
how
they
gain
their
money,

whether
legally
or
illegally”
[Bukhari]

Do
we
fall
under
this
descrip=on?

Do
we
follow

what
is
halaal
(permissible)
to
the
best
of
our

ability?

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Is
Islamic
Finance
knowledge
fardh
‘ein?
• Our
daily
ﬁnancial
transac=ons,
halaal
or

not?
Do
we
know?
Who
to
ask?

• What
about
more
complex
transac=ons?
A
muslim
is
expected
to
support
himself.

Muhammad
al-‐Shaybani
said
that

according
to
the
majority
of
the
fuqaha

from
the
Ahl
sunnah
wal
Jamaa’a
is
that

supporCng
one’s
self
to
the
level
of
need

is
fardh.
:: www.auscif.com :: facebook.com/Islamic.Finance.Au ::

Why Islamic Finance?
Universal demand for a
fair and just system that
is socially responsible
and sustainable.

Change the greedy and
inhumane system we
have created.

To provide a stable and
secure ethical
alternative, especially in
these uncertain times.

• The
Prophet
said,
“Two
hungry
wolves
let
loose

among
sheep
are
no
more
harmful
to
them

than
a
man’s
craving
a=er
wealth
and
status
is

to
his
religion.”
(Tirmizi)

Such
individuals
may
be
willing
to
compromise
themselves,

exploit
others,
their
religion
and
so
on.
Their
craving
drives
them

to
make
money
anyway
and
anyhow.

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"The best of people are those who are the
most beneﬁcial to the (other)
people" (Daraqutni, Hasan)

What
is
Islamic
finance?
• Islamic
finance
represents
financial
ac=vity
that
is

consistent
with
the
principles
of
Islamic
law
or
the

Shariah,
which
prohibits
unethical,
immoral,
specula=ve

ac=vi=es
as
well
as
interest,
gambling,
uncertainty
and
so

on.

• Islamic
finance
encourages
entrepreneurship,
mutual

coopera=on,
generosity
and
a
spirit
of
partnership
which

connect
the
capital-‐owner
with
real
economic
ac=vi=es

that
may
actually
contribute
to
the
welfare
of
society
via

commerce,
manufacturing,
construc=on
and
so
on.

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Growth and potential
• 1963 Egypt (town of Mit Ghamr) first savings bank based on profitsharing

commercial Islamic
• 1975 Dubai Islamic Bank (The first modernfunding to projects in
bank), Islamic Development Bank (provide
the member countries

• 1999 The first

index launched - The Dow Jones Islamic Market
Index (DJIM)
• Top 500 Islamic Finance Institutions by The Banker (No #1 Al Rajhi
Bank)

Islamic banks and
• 2011 A consortium of the industry's first financial industry
associations launched
International Islamic
interbank rate (alternative to LIBOR)

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Growth and potential
• Fastest growing segments of the finance service industry.

• Growing at over 10% - 15% per annum

• Estimated to be worth more than AUD$1.4 trillion

held by Islamic financial
may rise
• Assetsthan $5 trillion. (Moody’sinstitutionsService)

five-fold to
more
Investors
is expected
to 2.2
• The world’s Muslim population world’s totalto increase population.
billion by 2030 or 26.4% of the
projected
(Projections by the Pew Research Center’s Forum on Religion &
Public Life)

• What will they do in next 5, 10 or 20 years?

• IBF in Australia...

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ConvenConal
Banks
-‐
Money
is
considered
a

commodity
Surplus

Money

Exchange/sale

Money

Delay

The
sale
of
money
for
money
runs
contrary
to
the
nature

of
money
as
being
a
medium
of
exchange
(judge),
unit
of

account
and
store
of
value.

EG:
bank
loans
and
credit
cards

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Islamic
banks
-‐
Money
used
as
a
medium
of

exchange

Profit

Money

Asset

In
Islamic
finance
money
must
be
converted
into
something

useful,
which
in
turn
generates
profit
for
the
investors.

Linking
money
to
produc=ve
purposes
brings
into
ac=on
labour

and
other
resources
to
iniCate
a
process
from
which
goods
and

services
are
produced
and
benefits
passed
on
to
society.

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Islamic

ConvenConal

Bank

Bank

• Deal
in
goods
and
documents

and
not
in
money.

• Money
used
only
as
a
medium

of
exchange
for
purchasing
the

goods
for
the
purpose
of

leasing
or
selling
onward,

thereby
earning
income
or

profit.

• Hence,
profit
comes
with
Risk

and
Responsibility

• Deal
with
Money
&

documents
not
in
goods.

• Money
is
considered
a

commodity
that
can
be
sold/
bought
and
rented
against

profit
or
rent
that
one
party

has
to
pay,
irrespec=ve
of
the

use
or
role
of
the
lent
money

in
the
hands
of
the
borrower.

Adapted
from
"Understanding
Islamic
Finance"
M.
Ayub,
2007

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Basic modes of Islamic Financing
– Musharaka (Equity partnership, Joint
Venture)

• Eg: purchasing property or assets such as machinery
for a factory

– Mudaraba (Trustee/Investment Partnership)

• Eg: Bank deposit (saving and investment accounts)

– Murabaha (Cost Plus Sale)

• Eg: short term ﬁnancing

– Ijarah (Leasing)

• Eg: equipment ﬁnancing,

– Salam (Deferred Delivery Sale, pre-paid sale)

• Eg: agricultural produce

– Istisna (Manufacturing Sale)

• Eg: construction and Infrastructure projects

• In addition to the above business activities,
Islamic banks may provide services against
service charges or management fees.

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Other
complex
instruments:
eg.
Sukuk
3c
Periodic

payments

Investor

1a
Sukuk
1b
Cash

SPV

2a
Sale
of

assets

Seller

Issuer
/Trustee

2b
Price

3a
Lease
of

3b
Rentals
assets

4
Servicing
agreement

Lessee

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Servicing

Agent

AusCIF’s Islamic Finance
Quiz: Results & Answers
• Average Score 63%

Q.1
• True of False: One of the core aims or

objectives (maqasid) of the Shariah is the
preservation of Wealth (Maal).

• True

Q.2
• True or False: Subject matter in a contract

can not be anything that is not tangible. (Eg:
usufruct (beneﬁt from someone else's
property) which is commonly found in a
lease agreements)

• False

Q. 3
• True or False: It is permissible to sell a

commodity before it comes under our
control or we take (actual or constructive)
possession of it. (Excluding Salam and
Istisna arrangements)

• False

Q. 4
• True or False: Offer and acceptance are

non-essential attributes of the contract and
if they are missing then the contract can
not be described as Void (batil).

• False

Q. 5
• True or False: It is permissible to have

contract that combines contracts of sale
and lease if they refer to the same asset
(e.g. Hire Purchase contracts with e.g. a
lease for 3 years and sale at 30% at the end
of the lease period).

• False

• 43% Correct answers

Q. 6
• True or False: According to shari'ah,
anything that has economic value is
considered wealth.

• False


Q. 7
• True or False: Riba al-Fadl refers to a delay
in the settlement of one or both countervalues.

• False

“Gold
with
gold,
silver
with
silver,
wheat
with
wheat,
barley

with
barley,
dates
with
dates,
and
salt
with
salt;
same
quanCty

for
same
quanCty,
equal
for
equal;
transacCon
being
made
hand

to
hand
(i.e.
on
the
spot
payment).”
(Muslim)

Q. 8
• True or False: Exchanging US$105 with
AUD$100 on the spot (hand to hand,
without delay) is permissible.

• True

Q. 9
• True or False: Buying a house for eg.

$450,000 (to be paid in instalments over 5
years) is a permissible arrangement.

• True

• 85% correct answers

Q. 10
• True or False: Late fees are permissible as
long as they are mutually agreed to at the
start of a contract.

• False

• 36% correct answers

Q. 11
• True or False: Gharar refers to uncertainty
and deception (amongst other things).

• True


Q. 12
• True or False: In Musharaka (joint venture),
the profit ratio is fixed according to capital
contribution, while loss ratio can be
negotiated, but, must be fixed at the start.

• False

Q. 13
• True or False: In musharaka, partner who

invest eg. $50,000 (or 10% of total
investment capital) has right to specify from
the beginning that his share of proﬁt will be
$5,000 per year (which equals to 10% of his
initial contribution).

• False

Q. 14
• True or False: The result of a sale

transaction is instant and results in an
absolute transfer of the (asset) ownership.

• True

Q. 15
• True or False: Buying shares (stock) on a

short term price ﬂuctuations is considered
speculation (rather than investment) and
thus is a prohibited trading practice.

• True

Why
learn
about
Islamic
ﬁnance?
• Umar,
the
second
Caliph
and
successor
to

the
Prophet
Muhammad,
stated,

“Whoever
does
not
have
an

understanding
of
the
rules
of
Islam

should
not
deal
in
our
market”
(The
Life

of
Umar,
As-‐Sallabi
2007).

• He
also
warned,
“No
one
should
sell
in

our
marketplace
except
one
who
has

understanding
of
the
rules
of
Islam,

otherwise
he
is
going
to
consume
riba

whether
he
wants
to
or
not”
(ibid).

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Almir Colan

@almircolan

www.almircolan.com

almir@auscif.com

www.AusCIF.com

How Islamic Finance Works

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