According to a recent report the Islamic finance sector is worth more than $2.4 trillion USD. The sector serves nearly 2 billion Muslims worldwide and is built on the foundation of sharia or Islamic law. Even though the common practices of Islamic finance came into existence with the foundation of Islam, the establishment of formal Islamic finance started only about a century ago. The difference between conventional Western finance and Islamic finance is that certain practices and principles used in conventional finance are strictly prohibited under the Islamic laws.
Islam considers financing with interest payments as an exploitative practice that favours the financer at the expense of the borrower. Therefore, collecting and paying with interest is strictly prohibited. The rules of Islamic finance also ban participating in contracts with high risks and uncertainties. In Islamic finance, the material finality of the transaction is important. Each transaction must be related to a real underlying economic transaction. Parties entering contracts in Islamic finance share profit or loss, and risks associated with the transaction. No one party can benefit from the transaction more than the other party.
Due to the principles of Islamic finance, special types of arrangements were developed to comply with Shari’ah:
This is a common partnership where one partner (rab-ul-amal) is like an investor and provides the capital to another partner (mudarib) who is responsible for managing the capital. Both partners share the profits according to a pre-agreed rate.
Musharaka is similar to mudaraba, except that all parties involved in this partnership contribute the capital and share the profit and loss on a pre-agreed ratio. Musharaka has 2 types of partnerships:
· Permanent — under this partnership, the project does not have a deadline and continues to operate as long as the parties involved agree to continue operations.
· Diminishing — under this partnership, the bank and investor jointly purchase a property. Subsequently, the bank gradually transfers its portion of equity in the property to the investor in exchange for payments. This type of partnership is often used when acquiring properties.
A term used to describe a contract where the buyer and seller agree on a mark-up or “cost-plus” price for a good being sold. The price is marked-up because the buyer is allowed to pay over time, for example, with monthly payments. Because a set fee is charged rather than riba (interest), this type of loan is legal in Islamic countries.
Many argue that this is simply another method of charging interest. However, the difference lies with the structure of the contract. In a murabaha contract for sale, the bank sells an asset and charges profit, which, according to sharia, is permitted. Issuing of conventional financing and charging interest are interest-based activities, which are prohibited according to sharia.
This contract involves providing products or services on a lease or rental basis. In this type of financing arrangement, the person who owns the property leases the property to the renter in exchange for a stream of rental and purchase payments, ending with the transfer of property ownership to the renter.
The above mentioned Islamic financial instruments are the most commonly used in financing WAQF Projects. Additionally, we are seeing that blockchain is also being utilised for WAQF Development. The FINTERRA’s WAQF (Endowment) Chain uses a blockchain platform to raise development capital for WAQF projects that benefit communities, providing a ‘Social Solution for Blockchain’.