ISLAM COLUMN: Anatomy of Islamic Finance (3)

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ISLAM COLUMN: Anatomy of Islamic Finance (3)

  1. Companies involved in the following activities will be considered to be non-permitted business sectors:
  2. a) Conventional Finance (non-Islamic Banking, Finance and Insurance, etc.)
  3. b) Alcohol
  4. c) Pork related products and non-halal food production, packaging and processing or any other activity related to pork and non-halal food
  5. d) Entertainment (Casinos, Gambling, Cinema, Music, Pornography and Hotels)
  6. e) Tobacco


  1. f) Weapons, arms and defence manufacturing

This list is not exhaustive and is provided as a basic guidance to the broad principles involved.


  1. After companies have been screened by their business sector activity, the remaining companies are further examined on their finances to ensure that those companies are Shariah compliant. Only those companies that pass the following financial ratios will be considered Shariah compliant:


  1. a) Debt is less than 33.333% of total assets
  2. b) Cash and Interest bearing items are less than 33.333% of total assets
  3. c) Accounts receivable and cash are less than 50% of total assets
  4. d) Total interest and non compliant activities income should not exceed 5% of total revenue Companies that change financial compliance between two successive quarters will be monitored to check if their debt, and/or cash/interest bearing ratios fall within 33.333% +/- 5% (i.e. below 31.667% and 35% or above). If during the monitoring period any company remains above or below 33.333% +/- 5% for two consecutive quarters, the compliance of that company will change accordingly.

Appropriate purification of dividends at 5%. This ratio calculates the recommended purification amount to be paid by the investor.

Sukuk is a creation of IFIs to meet their liquidity requirements. Sukuk provide an opportunity to distribute the value of an asset/enterprise/project/usufruct into smaller amount certificates of equal value to create an opportunity for small investors to share the benefits of investment which is otherwise impossible keeping in view the larger amounts required to acquire or build an asset or enterprise/project. According to Shari’a standard # 17 investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after receipt of the value of the Sukuk, the closing of subscription and the employment of funds received for the purpose for which the Sukuk were issued. All Sukuk are tradable in secondary market.

There is empirical evidence to suggest that Sukuk structures were used within Muslim societies as early as the Middle Ages, where papers representing financial obligations originating from trade and other commercial activities were issued. The word, “Sukuk”, can also be traced back to classical commercial Islamic literature, used in reference to certificates for goods or groceries (“sakk al-bada’i”) as the method of paying the salaries of government officers, who would later redeem such certificates in line with their day-to-day consumption of such goods or groceries.


However, the Sukuk, as understood in its contemporary form, lies in a decision of the Islamic Jurisprudence Council (the “IJC”) dated 6-11 February 1988 which provided that, “any combination of assets (or the usufruct of such assets) can be represented in the form of written financial instruments which can be sold at a market price provided that the composition of the group of assets represented by the Sukuk consist of a majority of tangible assets.” [DIFC Sukuk Guide]


  1. Islamic insurance (Takaful)


Insurance is a business activity engaged in diversification (spread) of risks of a person among all participants. Traditionally insurance companies are providing indemnity against a certain type(s) of risks for a premium. Businesses are subject to many risks including fire, theft and accidents etc and insurance companies are sources of risk mitigation. Concept behind the organization and management of insurance business is working on the principle of cooperation. In its simplest form it is a fund created by a number (e.g. 100) of persons having same type of asset (e.g. cars) to compensate the one(s) who suffered loss due to destruction or theft of said asset (car). Everyone is contributing in the fund a specific amount known as premium (e.g. 5000) to be indemnified by an amount equal to loss of asset subject to a maximum limit (e.g. 150,000). Insurance business is also covering disability and or death of participants, known as life insurance. Practically this concept of insurance is changed to commercialization in the modern framework of business, where a company guarantees the making loss of policy holders good, by charging a premium, based upon length of period, probability of occurring loss and amount of compensation to be paid. Furthermore, there are re-insurance companies providing an opportunity to the insurance company to share the risk; as well as loss/compensation by sharing the amount of premium. From Islamic finance perspective sharing of risk among the participants is permitted, however, the present practices of insurance sector are not matching with the spirit of cooperation, encouraged by Islam.


According to AAOIFI, SS # 26, Islamic insurance is a process of agreement among a group of persons to handle the injuries resulting from specific risks to which all of them are vulnerable. A process thus initiated involves payment of contributions as donations, and leads to the establishment of an insurance fund that enjoys the status of a legal entity and has independent financial liability. The resources of this fund are used to indemnify any participant who encounters injury, subject to a specific set of rules and a given process of documentation. Thefund is managed by either a selected group of policy holders, or a joint stock company that manages the insurance operations and invests the assets of the fund, against a specific fee.


  1. Cash Financing

There are certain customer needs including payment of operating expenses, an urgent payment to a vendor, long distance travels and tours, children education, marriage expenses, health expenses and credit card facility etc. which cannot be fulfilled through any of above listed modes of financing, hence require cash loans. However, in present practice of Islamic banks one cannot get loan in cash except Qarz e Hasan (charity loan). Qarz e Hasna is not a business model in itself. Islamic banks are not charitable institutions rather commercial houses. In fact, Islamic banks or any other business can survive only through earning profit which does not exists in transaction of Qarz e Hasna. It is appreciable that Islamic banks must reserve a certain amount for Qarz e Hasna; however, that can only be done in a prosperous Islamic bank.


Time Multiple Counter Loan (TMCL) is a concept suggested by Council of Islamic Ideology (CII), Pakistan in its first report on “elimination of Riba from the economy” in 1980. As per this concept a needy customer can get cash loan without paying any interest from bank, however a small amount of counter loan/deposit (free of charge) for a longer period is to be provided to bank. Under this mode of financing a larger amount of cash loan with shorter maturity issued by bank is compensated through a smaller amount of loan/deposit for a larger period by customer. Bank can earn higher rate of profit by investing this shorter amount of cash in a long term project.


Some Islamic banks have introduced credit cards whereby a fee is charged to customer instead of charging interest for amount due, which needs to be further refined in the light of Shari’a principles.



To conclude there are major principle-differences in conventional and Islamic finance which needs to be appreciated in practice. Islamic finance is clearly different in business models from conventional finance. Over the years Islamic finance industry has succeeded in development of new products and services, although, further financial engineering is required to match the ever growing needs of business communities. Islamic finance has expanded in the area of banking, insurance and capital market operations. Islamic finance has promoted commonalities and unity among Muslim countries in the form of global institutions including AAOIFI, IIFM and IFSB etc. Islamic finance industry faces certain challenges including benchmark profit rate, cash financing and legal framework.

This post was written by Chris and was first published at


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