Essay: Islamic Finance and Its Impact on Customer Satisfaction (Page 2 of 2)

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Chapter Two

Literature Review

This part of the analysis is reviewing the Islamic finance, client satisfaction in Islamic finance, principles of Islamic finance and also the definitions of its product. Then the theories behind the Islamic finance are reviewed. The most a part of this chapter is predicated on books that square measure mentioned within the List of References.

2.1 The concept of Halal and Haram in Islam

The idea of Halal (lawful/permissible) and Haram (unlawful/impermissible) was introduced by the faith of Islam and this can beafter all the muse of Islamic finance. Each Halal and Haram are employed by Muslims throughout the planet and touching on something that\’s thought-about permissible and lawful beneath faith, and what\’s impermissible and punishable per shariah severally.
For many Non-Muslims the 2 words area unit associated with food and beverages that a Muslim is allowed or prohibited in line with Islam. However, for Muslims these words will be found in each facet of their life and it applies to everything from speech, dress code, the manner they behave, to their manner and dietary.

The higher than mentioned all social and moral idea reigns supreme conjointly within the monotheism finance and economy. Halal includes a protracted list of legal and allowable business activities, and Haram includes a protracted list of out and inadmissible business activities. On the opposite hand this Halal and Haram list isn\’t complete as a result of Muslim students in several countries have some variations within the interpretation of what\’s allowed and what\’s out, particularly once a replacement product comes into the market particularly in industry. Several of the IFIs have created their own jurisprudence boards1 that problems completely different opinion on new merchandise out there within the market, that add considerably to the variations in interpretations of what\’s Halal and what\’s Haram. a number of these general activities that Muslims don\’t seem to be allowed to take a position in area unit mentioned below:
• Alcohol, cinema (immoral), gambling, pork product, smut, tobacco and after all Riba (interest).
Actually, these prohibited activities aren\’t invariably prohibited. as an example investment in alcohol activities isn\’t allowed, however on the opposite aspect once identical alcohol is employed for the protection of life, like alcohol-based antiseptics, it\’s allowed. Another example states that in one case the finance of a significant luxury edifice was allowed wherever the casino wasim permissible, however the sale of alcohol at intervals the edifice was allowed to non-Muslims as a result of it had been the deemed necessary for its economic viability and as long because it wasn\’t oversubscribed to Muslims (not allowed) (Novethic, WP, 2009).

1 sharia law boards square measure comprised of freelance consultants (mostly Islamic lecturers and economists). areelaborate on within the following chapters
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2.2 Principles of Islamic finance

As it is apparent famous from its name, the Islamic finance system compared to traditional finance system is principally relating to the faith of Islam. The principles of Islamic finance square measure supported 3 main factors that are mentioned within the religious text and measure a very important a part of Shariah2 and Islamic jurisprudence. They’re Riba, Gharar and Maysir that are explained intimately below.

2.2.1 Interest (Riba)

In Islam it\’s not allowed to either receive or pay any form of interest on transactions involving cash or any business dealing. This prohibition primarily implies that the fixing prior to of a positive come back on a loan or any investment, as an award for waiting, isn’t permissible by Sharia law.

This prohibition has not been confined to Islam. Per Visser (2009, p. 39), supported passages from the Bible, the Christian Church at numerous times took a robust stand against hard to please and paying interest in any form
of business activities.

Also within the Old Testament, Jews were impermissible to demand interest on loans or investment from their own however they might charge interest on loans given to foreigners. Perhaps, best definition of Riba is given by Iqbal and Molyneux:

In its basic that means, Riba may be outlined as something (big or small), medium of exchange or non-pecuniary, in way over the principal in a very loan that has got to be paid by the receiver to the loaner at the side of the principal as a condition, (stipulated or by custom), of the loan or for AN extension in its maturity. per a accord of Islamic jurists it\’s identical that means and import because the up to date idea of interest. (Iqbal and Molyneux, 2005, p. 9)

2.2.2 Gharar

Gharar translated directly from Arabic it merely means that uncertainty or risk. Gharar is additionally as necessary in Islamic finance as Riba. Compared to Riba, Gharar is tougher to outline clearly in money transactions particularly in Islamic finance. Thus it\’s one in every of the foremost tough tasks for the consultants in sharia law boards in several IFIs to agree upon once there measure new product obtainable within the Islamic money markets.

2 Islamic law – the basic spiritual idea of Islam, particularly its law, systemized throughout the 2d and third centuries of the Muslim era capable 8th-9th centuries AD. (Encyclopedia Britannica)
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In this relation, Iqbal and Molyneux (2005, p. 14) state that, “jurists build a distinction between 2 varieties of Gharar: Gharar ahish (substantial) and Gharar yasir (trivial). the primary kind is prohibited whereas the second is tolerated since this might be ineluctable while not inflicting substantial harm to 1 of the parties. In several cases, it\’s merely out of the question to reveal all data (not as a result of the vendor needs to cover something, however as a result of it’s within the nature of the product). the client has got to trust the seller”. Its Gharar yasir (trivial) that generally causes issues for sharia law boards to agree upon. to stop Gharar in business transactions, the complete implications of this group action should be clearly famous to catching parties. Indifferent words there should not be ―asymmetric information‖ between parties as a result of it breaches the principle of shariah. Elgamal (2006, p. 58) states that, Gharar translated conceptually by faculty member Mustafa Al-Zarqaa means that “trading in risk, that cannot be defined”. He additional offers USA samples of naked choices, money futures, and derivatives that aren\’t backed by tangible and verifiable assets.

2.2.3 Maysir

Maysir is closely relating to Gharar. In some papers concerning Islamic finance or Islamic banking these 2 principles square measure used interchangeably although there\’s a main distinction between these 2 principles. Wherever in Gharar the most focus is on uncertainty (Risk), Maysir, translated from Arabic ―gambling‖, focuses on and prohibits transactions that square measure supported one side’s gain at the price of the opposite.

Conventional banking product equivalent to life assurance because of one side’s gain square measure prohibited in Islamic finance because it comes beneath Maysir. Once gambling, the player pays an explicit quantity of cash within the hope that he can gain a lot of larger quantity reciprocally, equally the standard life assurance policy wherever the assured hopes for an opportunity to form a gain.

The 3 principles that have mentioned higher than measure the most principles of Islamic finance. However, there square measure some additional general rules beneath that money transactions has become void in Islamic finance.

This could be a contract that involves immorality, that involves unlawfulness against public policy and that foundation or substance is unlawful or banned, or the other contract or agreement that is directly or indirectly is contrary to the divine principles of sharia law.

2.3 Islamic finance products

A large range of product square measure obtainable in Islamic finance or Islamic banking system and also the range is growing as demand for additional Islamic compliant product grow throughout the planet particularly in Islamic countries like in Pakistan. Generally, Islamic mercantile law is predicated on 3 modes that function the fundamental building blocks for different additional advanced money product.

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These 3 modes measure partnership based mostly, trade based mostly, and rental based mostly modes of Islamic finance. Nearly all Islamic finance products have come back beneath these 3 modes. The uses of every mode measures mitten by the aim and size of transactions, however all of them measure directly supported principle of Riba prohibition. One issue to recollect is that, as mentioned earlier, as a results of the distinction in interpretation not all of recent product square measure universally acceptable. The 3 mentioned modes square measure lined in details below.

2.3.1 Partnership based mode of financing

The Partnership based mostly or Profit-and-Loss-Sharing (PLS) modes suggests AN equitable sharing of risks and profits between the parties concerned in a very money group action or business, and embody Mudarabah, Musharakah and different hybrid product. in theory, Mudarabah and Musharakah square measure the foremost fascinating sorts of Islamic finance or Islamic banking.

Mudarabah is AN agreement between a loaner (Islamic bank), UN agency acts as AN capitalist, and a receiver, whereby the receiver will mobilize the borrowed quantity for his endeavor or the other money use. If profits square measure created they\’re going to be shared between the loaner and receiver per the reciprocally united ratios. Within the case of loss the loaner shares the losses in proportion to his contribution. Elazrag Hussein (2010) offers an honest example;

“an Islamic bank lends cash to a shopper to finance a manufactory, reciprocally that the bank can get a such that share of the factory‟s internet profits per annum for a chosen amount. This share of the profits provides for compensation of the principal and a profit for the bank to expire to its depositors. ought to the manufactory lose cash, the bank, its depositors and also the borrowers all collectively absorb the losses”.3 Musharakah

Musharakah is in its basic a business partnership or venture between 2 parties wherever one party can be a bank and also the different party its client. it\’s affected for a specific amount sort of a few months, year or over a year. Each parties square measure united on an explicit share of the profit to lean to every party. The profit of the bank should not exceed the share of its investment within the Musharakah. The losses, if incurred, are divided supported strict proportion to the equity participation quantitative relation, i.e. to the capital contributed by every party. As an example, if the bank invests sixty five and try and the client thirty Five, they have to share the loss within the same quantitative relation.

“All parties, together with the bank, have the correct to participate within the management of the project, however equally, all parties have the choice to waive such right. All parties agree through negotiation on the quantitative relation of distribution of the profits generated from the project, if any. This quantitative relation needn\’t coincide with the quantitative relation of participation within the finance of the project”. (Venardos 2005, p. 76).
3 Elasrag, Hussein, Global Financial Crisis and Islamic Finance (April 17, 2010).
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Musharakah is employed by Islamic money establishments for quality and/or property finance, capital finance, and etc. Each Mudarabah and Musharakah square measure closely connected product. Mudarabah differs from Musharakah within the means that solely bank is that the capitalist here, whereas in Musharakah all parties invest within the project. In Mudarabah management is that the right of the capitalist, whereas on the opposite aspect in Musharakah all partners will manage the project supported a pre-specified agreement. And at last, in Mudarabah the client doesn\’t bear losses if incurred, whereas in Musharakah profits and losses square measure shared supported the share of the investment.

2.3.2 Trade based modes of financing

Trade {based|based mostly|primarily based mostly} modes of Islamic finance became obtainable within the market a lot of later than partnership based mode, however its product gained dominance among different product terribly quickly and quickly.

Because it targeted a far larger cluster of investors, each personal and business customers, and it is also safer for each parties to take a position during this mode of Islamic finance, compared to partnership based mostly mode. Murabaha Finance

Murabaha is additionally AN agreement between a Islamic bank and its client. The client requests the Islamic bank to buy or import commodities on his/her behalf, with a promise to shop for them from the bank at damage and gross margin of the bank, and to be paid on delayed installments.

One of the foremost used sorts of Murabaha by Islamic banking customers is home finance. Murabaha can be named because the locomotive of Islamic finance as a result of it had been when the introduction of Murabaha that Islamic banking assets grew at double digits.

But there square measure numbers of critics among outstanding students criticizing Murabaha„s compliance with sharia law. As Usmani states, “It ought to ne\’er be unnoticed that originally, Murabaha isn\’t a mode of finance.

It is solely a tool to flee from „interest‟ and not a perfect instrument for effecting the important economic objectives of Islam. Therefore, this instrument ought to be used as a impermanent step taken within the method of Islamization of the economy. And its use ought to be restricted solely to those cases wherever Mudarabah and Musharakah aren\’t practicable.” (Usmani 1998, p. 104). 12

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This statement may be confirmed by watching a retardant that Murabaha contains. the matter is that the customer’s promise to shop for the commodities from Islamic bank thus once the bank has bought it, cannot be binding since this might be a consent that neither aspect is tributary right away to perform. the answer to the current drawback is that sharia law boards has accompany, is permitting banks to require collateral against losses incurred from a customer’s breach of promise. Salam Finance

As it has mentioned before, sharia law doesn\’t allow merchandising what you are doing not own however Salam is exempt from this condition.

In Salam, as long because the artifact is such that by each quality and amount and at full payment at spot, it\’s allowed to sell it in a very given future date.

The seller is duty-bound to own the artifact by the tip of contract. If the vendor doesn\’t have the artifact in hand at the time of execution of the contract, he/she should exist within the market.

Salam is analogous to forward contracts in typical financial set-up with the distinction that in Salam the whole quantity should be paid once language contract.

Salam is employed by IFIs in agricultural finance, pre-shipment export finance, and project finance. Iqbal and Molyneux (2005, p. 25), have explicit four basic rules that govern Salam:

1. The value ought to be paid fully at the time of the contract.
2. Product whose quality or amount cannot be determined by specification cannot be oversubscribed through the contract of Salam. AN example is precious stones.
3. Product may be oversubscribed solely by specifying the attributes. They cannot be particularized to a given farm, manufactory or space.
4. The precise date and place of delivery should even be such that.
There also are 3 major risks connected with the employment of Salam, as mentioned by Venardos (2006, p. 77), that per him reduces the Salam’s worth as a finance vehicle.

1. The danger of default by merchant that might simply partly resolved by getting some type of security from the vendor.

2. The banks ought to liquidate the products when delivery, AN inconvenience created additional serious by the Islamic legal rule or principles that a Salam client cannot sell the expected product before truly occupation of them. However this can be conjointly resolved by sharia law boards, UN agency permits Islamic banks to sell {the product the products} with conditions that the new contract is unconnected to the primary one (buying goods from seller), which the products square measure of precisely the same description, quantitatively and qualitatively, and with identical day of the month.
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3. the necessities of sharia law that if at the time of delivery the vendor will neither turn out the products nor get them elsewhere, the client has solely 2 choices: either withdraw his supply, or look forward to the products to become obtainable later, with no compensation permissible for the delay. In either case, the client loses all or a lot of the make the most of the employment of his cash or finance.

2.3.3 Rental based modes of financing

The Rental based mostly modes of finance have existed since the start of Islam. it had been used largely in relation with agricultural product. Ijarah are the sole kind utilized in this mode, however with time and also the development of recent product money establishments have further different additional sophisticated product beneath this mode.

The main plan of this mode is that the establishment or Islamic bank purchases a quality for its client and so hands it over to him/her on rental basis. this could be AN operational quality, wherever IFI act as sponsor of the quality or money quality, and wherever the client deals directly with the provider that the possession titles remains with the IFI till it\’s transferred to the client.

The two most used product in rental based mostly mode of finance square measure Ijarah and decreasing Musharakah. Ijarah finance

Ijarah is way love leasing agreement in typical financial set-up, however with a distinction that Ijarah doesn\’t involve interest bearing contracts and that they ought to be Shariah-compliant. once translated from Arabic, Ijarah means that to produce one thing on rent. Venardos (2006, p. 170) outline Ijarah as;

“a contract beneath that the bank leases instrumentation to a client for a hire fee. it\’s pre-agreed that at the tip of the leaseamount the client can get the instrumentation at AN united value from the bank, with the rental fees already paid being a part of the price”.

Ijarah is that the most used form of product, not solely among the rental based mostly mode product however conjointly among all product provided by IFIs, once it\’s involved the acquisition of assets for businesses.

Ijarah have typically been employed by personal customers for finance commodity like homes and vehicles. However recently it’s gained quality among business customers in relation with project and transportation finance.

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Ijarah may be used for nearly everything that would be hired, however some bound things that\’s prohibited in sharia law and some others like fuel, food and etc. aren\’t enclosed in Ijarah. Diminishing Musharakah finance

As with Musharakah, decreasing Musharakah may be a business partnership with the distinction that in decreasing Musharakah, at the tip of partnership, the one half becomes the complete owner of the quality in a very preset mechanism specified, once the contract is signed.

The transfer of the possession may be determined by a leasing agreement wherever the renter purchases the possession on a pro-rata basis through periodical lease payments. Iqbal and Molyneux (2005, p. 22) describe decreasing Musharakah as a contract between a financier (the bank) ANd a beneficiary during which the 2 comply with enter into a partnership to have an quality, however on condition that the financier can bit by bit sell his share to the beneficiary at AN united value, And in accordance with an united schedule.

Diminishing Musharakah is progressively being employed in sectors like housing and property, project finance, and construction. Decreasing Musharakah takes completely different shapes per the form of the transactions. A general rule is that once a client needs to shop for an artifact he/she approaches the IFI that agrees to hitch into partnership.

The client has got to pay a minimum of 10-20 % of the value, per IFIs needs, and also the rest is paid by the IFI. The share of IFI is then divided into units that the client has secure to buy one when another in a very much predefined schedule. Throughout this method the IFI gains on rent claimed per its proportion of share.

2.4 Derivatives

CFI derivatives embody decision and place choices, futures, forwards, and swaps and square measure used for hedging, arbitrage, and speculation. From the sharia law purpose of read most of the derivatives provided by CFIs square measure deemed to be Haram i.e. prohibited for IFIs as a result of these varieties of transactions visit the commodities which may not be in seller’s possession.

IFIs ostensibly permit derivatives for the needs of hedging and arbitrage, however interdict their use for speculation or gambling. As mentioned before, Islam prohibits Gharar and Maysir (gambling and speculation).

However, the necessity for a mechanism that would facilitate IFIs customers to manage supererogatory risks has prompted Islamic jurists and students to come back up with some standardized liquidity and risks management product, directly supported the commonly accepted Islamic finance modes.
A number of product square measure just like typical money product, Forward or futures contracts (a combination of Salam and Murabaha), decision (Arbun) and place choices, total come back or currency swaps and etc., however utterly at intervals ANIslamic framework.
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As there square measure numbers of various derivatives grow in Islamic finance, the criticism is additionally growing fromcompletely different elements of the planet by Islamic jurists and students contestation, that these varieties of product aren\’tfully compliance with sharia law. Jobst (2007) States that;

“Shariah students differ with the actual fact that futures ANd choices square measure valued largely by respect to the sale of a non-existent quality or an quality not within the possession of the vendor, that negates the sharia law. sharia law principles, however, needs creditors (or protection sellers) to really own the reference quality at the beginning of a group action.”

Anybody UN agency is at home with the foundations of sharia law will see that the thought behind these derivatives goes against the terribly pillars of Islam.

Therefore the creation and development of such product square measure, one in every of the foremost difficult tasks for Islamic finance practitioners or for Islamic banking practitioners. the scale of the Islamic spinoff market isn\’t famous however is sort of tiny and derivatives square measure a lot of less wide obtainable to IFIs than to CFIs (Visser 2009).

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