Islamic Finance: Basic principles of Islamic finance

I think it is time that I allocated some space to attend a few of the most frequently asked questions in order to clear misconceptions in the minds of readers about Islamic financing principles and practices.

Having been a conventional banker myself for over two decades, I have, more often than not, been confronted with the following question from my friends and ex-colleagues ever since I became an Islamic banker:

Is working by a Muslim for a conventional bank allowed under Sharia?

The first thought, which came to my mind while preparing an answer to this important question, was that there should have been no need for establishing Islamic banks had the working of the conventional banks been found to comply with Sharia principles.

Furthermore, from our earlier detailed discussion on usury, we learnt that any pre-fixed increment, no matter how small, over and above the loaned capital is usury. As such, it is clear that interest-based banks are usurious institutions and hence are out of line from Sharia perspective.

This question has frequently been put to different Sharia scholars of high repute and what you will read in the following lines is a combined gist of their assessment and replies.

The message of Islam is one that was sent to liberate humanity at both levels - the individual as well as society as a whole, and in the material as well as the spiritual form.

Equal and fair opportunities of earning one's livelihood and generation of wealth in an honest manner are very much part of the liberating message of Islam.

Clearly, banking and finance are the key elements in any modern day economy and we know that social justice centres around an economy. The question therefore arises that can an economy with unfair practices (including but not limited to usury) provide social justice to the members of society?

How would you change the unfair practices in an economy unless you technically understand its exploitative ways and are fully conversant of its pitfalls and weaknesses?

Based on this theory, some scholars feel that Muslims should be able to fully understand the modern economic systems prevalent in the West and the sophisticated financing products and techniques, both from theoretical as well as practical point of view.

If financial system in an economy is malfunctioning, then we need experts from Muslim community to advise us why and how it can be cured in order to bring it in line with Islamic parameters or to develop an alternate system conforming to Sharia.

In view of the foregoing, some scholars have assessed that there is need for Muslims to pursue higher studies in finance, economics, accounting, banking, insurance, etc., and also to take jobs in these disciplines but with a clear purpose to develop alternate Sharia-compliant products.

Some scholars are averse to the idea of even going near the professions or financial transactions connected to interest. I appreciate that it may be easier for a self-employed Muslim to conduct his business in a manner so as to completely avoid usury.

However, if a Muslim is an employee of a conventional bank, the choice is limited by the sheer scarcity of Islamic banks in the Gulf region in particular and the Muslim world in general.

Another set of scholars is a wee bit sympathetic towards such Muslims. Nevertheless, they set the following strict criteria: You must have sincerely exhausted all the options to get a job in an Islamic bank Alternatively, you have also tried to get into an organisation whose core income doesn't comprise interest.

It is only after trying hard enough and not being successful that you accept a job in a conventionally run financial institution.

It should be very clear in your mind that you are doing it unwillingly and in compulsion since you have to support yourself and the family members.

You should not consider making it your lifetime career, even if you have started to climb the hierarchy ladder in a conventional bank.

You must apply yourself fully to know as much as you possibly can about your job and the related procedures, systems and environment with an intention of being able to come up with Sharia-based alternate.

You must continue to look around for another job, either with full Sharia compliant environment or at least in an organisation whose core income is not interest.

Scholars agree that under the present circumstances where the interest-based financial system is widely practiced in the Muslim countries; it becomes the moral responsibility of the respective governments to initiate large-scale shift towards the Islamic financial system.

One way to step forward is to structure state's development projects Islamically. On the other hand, region's Islamic banks should also gather required courage to start underwriting large development projects together by forming consortium, rather than seeking to carve out smaller Islamic tranche in a conventionally arranged syndication facility.

I am sure the above moves will trigger a gradual and systematic shift in the Gulf region from an overwhelmingly conventional banking environment towards the Islamic banking practices.

As the overall size of Islamic banking grows in the region, it will provide opportunity to scores of bankers to switch to the Islamic banking.

Apart from assistance from banks, what other forms of raising large funds can a joint stock company resort to, without indulging in interest?

This question was sent while I was still explaining various Islamic financing products. While I apologise for the delay, the reply is as follows: When public joint stock companies need liquidity for expansion or capital expenditure purpose, they either resort to seeking term loans, or issue debentures or bonds.

One way deliberately avoided by the companies is to issue fresh stocks since it is feared that the move may dilute shareholders' value and will reflect on the earnings per share (EPS) ratio.

We know that EPS ratio is very dear to PJSCs since it measures company's performance and standing in the market. The lesser the number of shares, the greater the ratio, and vice versa.
In addition to utilising the reserves, the option of issuing fresh stock is the only one to raise large funds without indulging in interest.

Whilst still on the subject, kindly note that if you are a shareholder of a joint stock company, please keep a watch on its borrowings through annual and interim accounts and also at the annual interest expense it is incurring.

This is due to commonly agreed parameter by various Sharia scholars to de-list a company from Islamic investment point of view should the interest based borrowings exceed one-third of the value of its assets.

In such situation, it is advisable to liquidate your investment portfolio even if you have to suffer some loss since its continuation would be against the established Sharia parameters for investment.

The author is Head of risk management at Dubai Islamic Bank.