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Saturday, January 09, 2016   #1  
 Agha Shahriyar Khan   Join Date: Jun 2015
Location: Karachi
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Possibility of interest free Islamic Financial system.

Introduction

Islamic interest free financial system is possible in the modern world through Islamic banking system. It is not only
"interest-free" but also provide a true picture of the system as a whole. While prohibiting the receipt and payment of
interest is the nucleus of the system, it is supported by other principles of Islamic teachings advocating individuals'
rights and duties, property rights, equitable distribution of wealth, risk-sharing, fulfilment of obligations and the
sanctity of contracts. Similarly, the Islamic financial system is not limited to banking but covers insurance, capital
formation, capital markets, and all types of financial intermediation and suggests that moral and ethical aspects in
the regulatory framework are also necessary in addition to prudent and sound controls.

Principles of an Islamic financial system

The basic principles of an Islamic financial system can be summarized as follows:

1-Prohibition of interest. Prohibition of riba, a term literally meaning “an excess” and interpreted as “any unjustifiable
increase of capital whether in loans or sales” is the central tenet of the system. Allah says
"They say, trade is like interest and Allah has allowed trade and prohibited interest”.

2-Risk sharing. Because interest is prohibited, suppliers of funds become investors instead of creditors. The provider
of financial capital and the entrepreneur share business risks in return for shares of the profits.

3-Prohibition of speculative behavior. An Islamic financial system discourages hoarding and prohibits transactions
featuring extreme uncertainties, gambling, and risks.

4-Sanctity of contracts. Islam upholds contractual obligations and the disclosure of information as a sacred duty.
This feature is intended to reduce the risk of symmetric information and moral hazard.

4-Shariah-approved activities. Only those business activities that do not violate the rules of shariah qualify for
investment. For example, any investment in businesses dealing with alcohol, gambling, and casinos would be
prohibited.

Simple derivatives, such as forward contracts, are being examined because their basic elements are similar to those
of the Islamic instrument of deferred sale. Project finance, which puts emphasis on equity participation, is another
natural fit for Islamic finance.

ISLAMIC BANKING

• The prohibition of interest by Islam is the base of the development of Islamic Banking Philosophy. The Islamic
system order based on a set of principles constituting the concept and philosophy as enunciated explicitly in the
Quran.This philosophy provides what can be understood as the Islamic system of social justice.
• In Islamic law some gain has been prohibited which are generally fixed or if there is no concept of risk shearing.
Conventional Finance believes in return without risk, whilst Islamic Finance prohibits the latter and enforces the
opposite
• Islam prohibits interest but it does not means, that it prohibits all gains on capital. The only increase stipulated or
sought over the principle loan or debt is prohibited in Islamic sharia law
• Islam deems profit, rather than interest, to be closer to its sense of morality and equity because earning profits
inherently involves sharing risks and rewards
• Islam encourages shearing of risk among lender and borrower, Islamic financing system is based on this principle, it
has also another character of owing and handing of real assets, its involvement in trading, construction and leasing
using Islamic mode of financing
• Profit has been recognized as ‘reward’ for (use of) capital and Islam permits gainful deployment of surplus
resources for enhancement of their value.
• Financial transactions, in order to be permissible, should be associated with goods, services or benefits. At macro
level, this feature of Islamic finance can be helpful in creating better discipline in conductive of fiscal and monetary
policies
• All such things/assets corpus of which is not consumed with their use can be leased out against fixed rentals. The
ownership in leased assets remains with the lesser that assumes risks and gets rewards of his ownership

MAJOR MODES OF ISLAMIC BANKING AND FINANCE

1. Murabaha
Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as
a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain
goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance

2. Ijara
Ijara or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and
wage in case of hiring of persons
Ijarah-Wal-Iqtina

A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed
rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the
ownership in the asset would be transferred to the lessee.
4. Istisna

It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and
future delivery or a future payment and future delivery. Istisna’a can be used for providing the facility of financing the
manufacture or construction of houses, plants, projects and building of bridges, roads and highways.

5. Bai Muajjal
It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of
the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity
and the margin of profit is mutually agreed..
6. Mudarabah

A form of partnership where one party provides the funds while the other provides expertise and management. The
latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a pre-agreed basis,
while loss is borne only by the provider of the capital.
7. Musharakah

Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of
profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are
mixed with the funds of the business enterprise and others

8. Bai Salam
Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes
to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of
contract..

9. Qard Hassan (Good Loan)

This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However,
the debtor may, at his or her discretion, pay an extra amount beyond the principle amount of the loan (without
promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to
the creditor, this transaction is a true interest-free loan.

2.4 RATIO OF PROFIT

There is a difference of opinion among the Muslim jurists about the Ratio of Profit.
In the view of Imam Malik and Imam Shafii, it is necessary for the validity of Musharaka that each partner gets the
profit exactly in the proportion of his investment. Therefore, if A has invested 40% of the capital, he must get 40% of
the profit. Any agreement to the contrary which makes his entitled to get more or less than 40% will render the
musharkah invalid in Shariah.
On the contrary, the view of Imam Ahmad is that the ratio of profit may differ from the ratio of investment if it is
agreed between the partners with their free consent. The third view is presented by Imam Abu Hanifah which can be
taken as a via media between the two opinions mentioned above.

CONCLUSION
In short we can say that Islamic finance system is not a theoretical system, it is practical system and can be
implemented in the modern world through the principles of Islamic banking and financing. Islamic financing system
is the only system which put forward the solution of all economic problems of the world
Pease give your critical remarks
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