Islamic Finance - Stocks that comply with sharia
Musharakah participation is a type of equity partnership investment that serves as the foundation for the Shari'ah-based equity participation principles. It is comparable to investing in stocks with equity in a traditional capital market, but such investments are only permitted in Shari'ah-compliant companies. Only when a company's primary business operations do not conflict with Shari'ah law can its stock be considered to be compliant with the law. Participation in industries like financial services based on interest, alcohol, products relating to pigs, guns, and entertainment are examples of prohibited main business operations. Shari'ah-compliant businesses must also abide by a number of financial criteria, such as restricting leverage involving interest-based borrowings to a specific prescribed ratio. Although the permissible ratio of conventional leverage and the usage of interest-based borrowings may appear to be at odds with the fundamental principles of Islamic finance, Study Guide Three will explain the background of this guideline. To ensure that the available stock satisfies Shari'ah-compliant standards, it is periodically screened. The applicable Shari'ah boards of the individual screening agencies define the screening standards, and ratings are frequently released. Examples include the Dow Jones Islamic Market Index (DJIM), the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) stock screening methodology, and the Kuala Lumpur Shari'ah Index (KLSI), which is being replaced by the FTSE-Bursa Malaysia Hijrah Shari'ah Index.
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Islamic Finance – Islamic Capital Market
Islamic Stock Exchange ( ICM) ICM refers to capital market activities that are conducted in accordance with Shari'ah guidelines. The market's agents are allowed to conduct their companies in any activity, with the exception of those that are against Shari'ah regulations and principles. indicative of the curriculum • The ICM is essential in luring investment capital and directing it toward useful endeavors. While the secondary market offers liquidity to market players, the primary market gives monies directly to the operations of Shari'ah-compliant businesses. More economic actors participate in these markets for both investment and liquidity reasons. The capital market's instruments' liquidity meets the demands of various investor classes with various time horizons for making investments. To address the needs of those who desire to invest in accordance with Shari'ah standards, the ICM has developed over time to now offer a wide range of goods and services. These comprise Shari'ah-compliant securities, mutual and private equity funds, asset-backed securities, short-term financial products for the Islamic Money Market (IMM), and Islamic derivatives (structured products). Additionally, services like merchant/investment banking, stock brokerage, and asset management firms assist the ICM. Now, a brief explanation of each of these goods and services will be given. Islamic Finance - Direct Financing
A new method of financial market intermediation is produced by the growth of capital markets. Through the issuance of securities by corporations, money is directly raised from investors during the direct financing process. Corporations can gain direct access to capital by issuing securities, or documents that can be traded on the secondary market. This adds liquidity to the financial market. In direct finance, the primary method of risk compensation is to reward investors' returns through dividend or coupon payments as well as capital gains. A risk-return relationship will be reflected in the mobilization and allocation of money because the suppliers of funds are often risk averse. The necessary return increases with risk level. Issuer risk is unique to direct financing and necessitates more openness and disclosure. Furthermore, for any issuance of securities, some countries, like Malaysia, Hong Kong, Singapore, the European Union, and the United States of America, demand trustworthy and independent ratings. A ratings system's purpose is to offer an unbiased assessment of a specific security's merits and the issuer's creditworthiness. It functions as a grading system that offers an objective assessment of credit quality, focusing in particular on the issuer's capacity to pay the required finance at maturity. Islamic Finance - Utilizing Islamic finance
The spread (the difference between their cost of funds and profits on financing) is how financial intermediaries make money from indirect financing. With the help of this spread, they are compensated for the risks they take on, one of which is the credit risk provided by their clients. By managing the portfolio of assets with varied risk exposures associated with consumer and business financing, financial institutions act as intermediaries, pooling the risks incurred by depositors based on their risk preferences and investment horizons. Financing services are typically offered by finance businesses to market sectors that are not serviced by merchant banks, which engage in wholesale banking, and commercial banks, which concentrate on retail banking. Hire purchase, leasing, small consumer loans, personal loans, and factoring are the focus areas for finance organizations. Finance businesses, however, were absorbed into ICB conglomerates as they started to play a bigger function and take on that of ICBs. Additionally, the Basel accords' risk-weighted capital adequacy criteria made it more financially sound to incorporate the financing company's operations inside the bank rather than as a distinct division. Islamic Finance – Musharakah Mutanaqisah
Musharakah mutanaqisah, where the word mutanaqisah means "to lessen," is a subtype of the Musharakah contract. As a result, Musharakah mutanaqisah, also known as Diminishing Musharakah, refers to a type of partnership that gives the capital provider a way to lessen or be free of the joint ownership once the initial investment time has been satisfied. Islamic Finance - Indirect Financing System -Products available
The process of financial institution intermediation is another name for indirect financing. In the IFS, a financial intermediary takes the form of an Islamic Commercial Bank (ICB). The ICB receives surplus funds from the deposit products it offers, such as savings and/or current account deposits based on Wadi'ah (safe custody) or Qard/Hassan (interest-free loan) contracts, as well as investment and savings accounts based on Mudarabah. A range of financing options, such as equity-based and debt-based financing, are used to channel money through ICBs. According to predetermined terms and circumstances, the ICB offers the institutions and agents of the surplus economy avenues for investment and the deficit agents for finance. Islamic equity-based finance solutions use contracts such as profit-sharing partnerships (Mudarabah), joint venture partnerships (Musharakah), and decreasing partnerships (Musharakah Mutanaqisah). Islamic debt-based financing solutions use contracts such cost-plus sales (Murabahah), leasing (Ijarah), deferred delivery sales (Salam), and manufacture-sales (Istisna'). IFIs also offer service-based activities through agency (Wakalah) and safe custody (Wadiah). Islamic Finance - The Operation of Islamic Financial System
All financial systems serve two fundamental purposes: to raise excess cash from individuals and organizations in the economy and to distribute them to units with a deficit. A borrower is an example of a deficit unit, whereas an investor is an example of a surplus agent. For surplus units, raising money results in returns that generally increase their wealth and financial stability. Additionally, it enables deficit units to increase their purchasing power and productive capacity, which raises an economy's potential for both production and consumption. Either debt or equity can be used to mobilize Islamic funds or deposits. Islamic finance produces a succession of debts through debt-based transactions, which the debtor must settle through prearranged regular payments. Islamic deposits take on partial ownership of a company when they take the form of equity, and their returns are based on how profitable the company will be in the future. The financing process makes it possible for potential users of funds to compete for them, which incentivizes the provision of funds. In essence, the financial system should guarantee the supply of funds when their usage has a positive real economic value, meaning that the user of the funds anticipates earning a return greater than the returns paid to the fund supplier. To enable investors and other fund suppliers to evaluate the risks and anticipated returns connected with the planned use of money, the financial process necessitates the thorough disclosure of pertinent information. Islamic Finance - Interest-based systems in use today
The interest rate serves as a price mechanism for efficiently allocating resources from surplus units to deficit units in the interest-based system used by conventional financial institutions. Loan contracts make up the underlying contracts, which may take the shape of deposits made by consumers or loans given to customers/borrowers. Customers/borrowers generate interest income, which is then paid to depositors. The spread, also known as the financial institution's net interest income, is the margin. As demonstrated by the precedent-setting case of Foley v. Hill, the core of traditional financial institutions is solely predicated on the lender-borrower (debtor/creditor) relationship (1848). Islamic Finance -Features that make Islamic financial systems distinct
Even though the IFS performs many of the same tasks as its traditional cousin, it also has several distinctive properties. These are essentially as follows: I Governance, oversight, and regulation Relevant Shari'ah considerations in the form of principles, norms, opinions, and requirements must be taken into account when it comes to the regulation, supervision, and governance of IFIs. These promulgations or declarations may take the form of Shari'ah resolutions converted into judgments and opinions that the Islamic financial sector would follow. For instance, a deposit made under a Mudarabah contract is not considered a debt to a bank in the case of an investment account because it is not a loan. Further consideration of this should be included in pertinent regulatory frameworks and directives, such as the Capital Adequacy Ratio (CAR). Financial services and products Financial institutions must adhere to Shari'ah law while offering financial products and services. In other words, all Islamic financial services and products must adhere to Shari'ah regulations. The underlying contracts for these goods and services must not contain any forbidden terms and conditions, such as usury/interest (Riba) or uncertainty (Gharar). Additionally, the goods or services must not be connected to any activity that violate Shari'ah law, including the sale of pork, the use of intoxicants, or the operation of games of chance. (iii) Real economic activity financing Islamic financial/investment products' returns in financing or investment operations must be correlated with the revenues produced by the underlying commercial activity and cannot be merely determined by the cost of capital or interest rates. Therefore, Islamic finance offers financing for actual economic activity, particularly through its equity-based solutions. Investment finance via Mudarabah or Musharakah is an agreement by the Islamic financial institution to share in the risk involved with business endeavors in order to be eligible for a portion of the profits made from a particular business venture. (iv) Risk allocation and fair distribution The profit allocation procedures and distributions to claim holders in equity-based financial transactions must be fair and based on a mutually agreed-upon profit-sharing ratio or profit and loss-sharing ratio with proper information disclosure. (v) A system of internal Shari'ah controls The financial institution's attainment of Shari'ah compliance is essential to Islamic financial activities. An internal Shari'ah control system should be built to ensure that all financial activities are carried out in conformity with Shari'ah guidelines in order to accomplish this. An internal Shari'ah review guarantees adherence to the Shari'ah principles and regulations set forth by the relevant agencies, including the financial institution's Shari'ah board and the regulator. Shari'ah board, vi Scholars who serve on shariah boards have the responsibility of evaluating the financial institution and endorsing its goods and services. Many regulatory organizations, including AAOIFI, as well as specific IFIs have adopted the practice that the decisions made by the Shari'ah board are legally binding on the IFIs. Any deliberate disregard for the guidelines and judgments of the institution's Shari'ah board would be seen as a violation of these qualities. Corporate social responsibility is number vii. In addition to satisfying regulatory and supervisory requirements, the reporting of the Islamic financial institution should take into account the information demands of shareholders, investors, and other pertinent stakeholders in terms of corporate social responsibility. (viii) Zakat requirements Similar to a wealth tax, the payment of Zakat is a yearly obligation. After a set length of time has passed and the minimum requirements have been met, the amount paid is computed. Either by applicable law or the IFI's articles of association, the payment of Zakat by IFIs is required. By giving to the appropriate Zakat organizations or designated Zakat beneficiaries, IFIs make it easier for their Muslim shareholders, investors, and depositors to fulfill their Zakat requirements. Islamic Finance - Musharakah
A Musharakah contract is a type of equity investment in a partnership. It is comparable to investing in stocks and financial securities in a traditional capital market, but the investments made must only be in assets that are compliant with Shari'ah law. |
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