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Prague, March 22nd 2011. PRINCIPLES OF ISLAMIC FINANCE AND INTEREST Mr Sabri Ulus Turkiye Finans Participation Bank Head of Treasury Dept.

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Presentation on theme: "Prague, March 22nd 2011. PRINCIPLES OF ISLAMIC FINANCE AND INTEREST Mr Sabri Ulus Turkiye Finans Participation Bank Head of Treasury Dept."— Presentation transcript:

1 Prague, March 22nd 2011

2 PRINCIPLES OF ISLAMIC FINANCE AND INTEREST Mr Sabri Ulus Turkiye Finans Participation Bank Head of Treasury Dept.

3 Islamic Finance – “Principles of Islam” Teachings in Islam covers both religious and secular life. Islam spells out the guidelines on what characteristics economic and financial transactions should ideally have and what must be avoided. Sharia laws determines what contracts or products or investments are permitted (halal) and what are forbidden (haram). What is the goal? To have fair, equitable and just economic and financial transactions and processes that will benefit all participants and promote cohesion and well-being of the society. What are the basic principles of an Islamic system? → avoids interest (Riba) on money → avoids excessive uncertainty or risk (Gharar) → avoids impermissible games of chance or gambling (Maysir)

4 What are the sources of Islamic Jurisprudence? Quran Holy text that contains the teachings of God Sunnah Record of the life of the Prophet Sharia Islamic Law, derived from the Quran and the Sunnah Hadith Narration of the sayings and acts by the Prophet Ijtihad Research by scholars to answer questions that are not explicitly addressed Hanafi, Maliki, Shafi’l and Hanbali (Sunni) Jafari (Shia) Ijma Qiyas Al-Istihsan Maslaha Urf Islamic Finance – “Principles of Islam”

5 Some of the methods of Ijtihad: Ijma: Consensus or agreements arrived at by a group of scholars Qiyas: Reasoning by drawing analogies between situations Al-Istihsan: Judicial preference of one practice or answer over another even though the former may not have compelling support or argument in its favour Maslaha: Decisions or conclusions based on bring benefits or the avoidance of damage to public interest Urf : Customs or knowledge of society The opinions or outcomes of ijtihad, which are regarded as secondary sources of the Sharia, must not give rise to situations that violate the basic teachings of Islam. Islamic Finance – “Principles of Islam”

6 Riba (usury or interest) Quran verses [2:278 – 279] 2:278. O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers. 2:279. If ye do not, take notice of war from Allah and His Messenger: but if ye turn back, ye shall have your capital sums; deal not unjustly, and ye shall not be dealt with unjustly. A translation: … you should collect your principal without inflicting or receiving injustice (without increase or decrease in the principal sum lent) Why the prohibition of riba? What is the issue here? Exorbitant interest rates and possible exploitation of the poor borrowers by rich lenders? Islamic Finance – “Principles of Islam”

7 Two Ahadith on Riba (usury or interest): Numerous Hadith deal with Riba. Here are two examples. The Prophet said (as reported by Bukhari and Muslim): * “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt; like for like, hand to hand, in equal amounts, and any increase is Riba. If these kinds differ, sell as you like provided it is hand to hand Bilal visited the Messenger of Allah with some high quality dates, and the Prophet inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. The Messenger of Allah said: “this is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other.” Though the first Hadith listed six goods, the meaning of Riba is extended to money in modern economies. Islamic Finance – “Principles of Islam”

8 Some arguments of the Islamic scholars for the prohibition of the interest: Interest has not been universally accepted even in conventional circles The payment of any type of interest was considered to be usury up until recent times even in the West Money is not in itself capital and therefore does not “deserve” to earn a return It is unfair on the face of it that the person lending the money should be guaranteed a return independent of the success of the venture for which it was lent Separating the act of lending from the purpose of the loan can easily lead to excessive risk taking because of the lack of monitoring Even in the case where the investor knows the purpose of the loan they may not show adequate care in assessing risk given “collateral” or other guarantees on their principal Islamic Finance – “Principles of Islam”

9 Some arguments of the conventional economists for the use of interest: The saver must be compensated for postponing consumption and for the effects of inflation That the ability to earn interest would induce some individuals to postpone their consumption (so that they could consume more in the future when they received their greater sum) If we prohibit interest, we may cause a lower rate of savings However, even with high interest rates in many Western countries we observe very low savings rates (esp. in the US). Islamic Finance – “Principles of Islam”

10 In 1950s and ‘60s, a group of scholars, such as, Muhammad Iqbal, Abu Al-A’la Al-Maududi, Baqir Al-Sadr and Sayyid Qutb, investigated some questions concerning the Islamic finance. Since interest on debt is forbidden, how governments, companies and individuals who need capital or cash may obtain funding? Can an economic system that observes these prohibitions be viable and efficient? Islamic Finance – “Principles of Islam”

11 Since the 1970s, Islamic finance has undergone much development and today offers a viable alternative to conventional finance. But the progress in the conventional finance also complements that in Islamic finance (i.e. securitization techniques). Characteristics of the Islamic finance: Risk sharing and partnerships are much encouraged in Islamic finance. Focus on unity, cooperation and social cohesion. (As far as possible) Financial contracts in Islam finance should serve a practical economic or commercial need. ≈ physical assets or commodities Islamic Finance – “Principles of Islam”

12 No aspect of Islamic finance causes more consternation to people used to conventional financial markets than the Muslim prohibition against “Riba,” which is usually described as: But there are also other transactions that are equally forbidden. “Muslims can’t pay or receive interest.” Islamic Finance – “Principles of Islam”

13 Some arguments of the conventional economists for the use of interest: The price of goods and services may be higher at the end of the loan period than today and the saver needs to be compensated for this inflation But... The borrower didn’t cause the inflation so why should he have to compensate anyone for it? If you are worried about prices going up, nothing is stopping you from consuming now at the current prices. Would you then agree that if prices are expected to decrease, that you would be willing to get back less than you loaned? Islamic Finance – “Principles of Islam”

14 Islamic investors have a principled, reasoned argument against the payment or receipt of interest and that anyone who wants to do business with those following the Shariah law will have to respect this. Nonetheless, It is true that Muslim investors (savers) want to earn a return on their investment (savings) that is equivalent to what could be earned by conventional means ≈ “eat your cake and have it, too” This leads to the development of financial transactions and structures meant to bring this about Islamic Finance – “Principles of Islam”

15 Such an effort might be regarded by some as; (i)cynical and an exercise in “Shariah arbitrage,” or (ii)as a sincere attempt to design modern investments that facilitate the development of well functioning financial markets while simultaneously respecting the beliefs and restrictions of Islamic investors. However, our purpose here is not to make moral judgements, but to describe and explain what these structures are and how they are used. Islamic Finance – “Principles of Islam”

16 Conventional Finance Interest payment as the cost of capital or finance Risks are traded among the market participants Islamic Finance Interest payment (riba) on debt is haram Risks or uncertainties should be minimized Islamic Finance – “Principles of Islam”

17 THANK YOU Islamic Finance – “Principles of Islam”

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