Islamic Finance in the EU Anu Kõve PhD Student Faculty of Law University of Tartu 2011

Why is Islamic Finance relevant ? Some Muslims in the EU Their growing interest in Sharia-compliant financing More than 350 Islamic financial institutions worldwide in more than 75 countries Yearly increase of the turnover of Islamic financial services is up to 20 %

Basics of Islamic moral economy Prohibition of interest (riba) as usury - Including fixed return generated by interest Prohibition of uncertainty (gharar) Prohibition of the elements of gambling (maysir) Capital can increase within real economy only Conclusion: -interest is prohibited, -trading is allowed (Prophet Mohammed was a merchant) and so is profit.

I Example of trading: mudaraba Investor (rab al mal) contributs the capital share Entrepreneur (mudarib) contributs managerial share Mudaraba Proceeds of the joint venture will be divided between the investor and the Entrepreneur. In case the joint venture will not be successful – investor loses his contribution and entrepreneur the resoures spent on managing the Investment – the concept of profit and loss sharing (PLS)

II Example of trading: murabaha Seller Contract of sale I, purchase price 10 units, payable immediately Purchaser Contract of sale II, purchase price 10 units + 2 units premium; deferred purchase price Bank delivery

Differences between profit and interest Interest return on capital Interest guaranteed Fixed return Return on deposit Profit Return on a project Risk of loss involved Variable return Return on joint ventures

Sharia Board Shariah scholars - supervisory and consultative functions Review the conformity of operations with Sharia Supervise the development of financial products, determine the Sharia-compliance of the products and investments Carries out Shariah audit

Islamic retail banking services Current account – loan to the bank, no profit- sharing, service fees applicable, unless minimum balance is kept on the account. Deposit – payable on demand or term deposits, contractual agency between the client and bank; the deposit will be invested by the bank and the profits will be divided between the depositor and the bank (PLS!).

PLS in deposit contracts Deposited sum will be invested by the bank within the pool of funds during the agreed period Example of the calculation of profit: 1)Gross income – 1,5 % of administrative costs 2)Net income- share profit of the bank e.g. 50 % 3)Gross share of profit - contribution to the profit stabilisation reserve, e.g. 20 % 4)Share of the depositor will be credited on the account.

Definition of Islamic insurance A process of agreement among a group of persons to handle the injuries resulting from specific risks to which all of them are vulnerable -The process includes payment of contributions as donations and leads to the estbalishment of an insurance fund, that will be used to indemnify any participant who encounters injury, according to pre- agreed rules. -The risk should be the one that could probably occur, but not sth that depends on the absolute will of the participant (Accounting and Auditing Organization for Islamic Financial Institutions, Standard 26)

Islamic Insurance Origins -Takaful = shared responsibility, guarantee, collective assurance and mutual undertakings -“Tie your camel first and then put your trust in Allah” -Although other references to the mitigation of risks date back to the first days of Islam, Islamic insurance was established in the second century of the Islamic era

Management of Islamic insurance fund Either by a selected group of policyholders, or An agent: a company that manages the insurance operations and investments for a fee -There are 2 accounts: one for the rights and liabilities of the company and other for the rights and liabilities of policyholders. -When the company is liquidated all funds pertaining to insurance will be spent for charities

Parties to Takaful Participants (contribute to the mutual fund and may bear any deficit that may occur) Insured (participants who face the risk and are assisted by the fund) Beneficiaries (the insured who actually benefit from the co-operative fund) Takaful operator (the fund managed by a registered/licensed body, manages the fund according to Sharia principles and provides financial security) - Actually the contributions are paid to 2 different funds: investment fund managed according to mudaraba and the other one is treated as charities – such division of responsibilities is the reason why Takaful company is called rather Takaful operator than insurance company.

Main differences b/w conventional insurance and Takaful Takaful -Lapse of premium payment of contribution does not make policy invalid -Original premum payment goes back to the insured after deducting his share of costs -The profits of investing premiums belong to the insured after deducting the company’s share as Mudarib -Policy-holders are entitled to vote managers of the company Conventional insurance - Lapse of premium payment makes policy invalid -Neither the original premium nor any other part of it goes back to the insured -Profits of investing premiums assets belong to the insurance company only -Policy-holders are not entitled to vote managers to the company

Life assurance In life policy a Muslim appoints a trustee who receives all the payable money and distributs it among the successors of the deceased according to the principles of inheritance and bequest If the assured dies before the policy matures, the beneficiary is entitled to the whole amountof premiums, the bonus and and dividend and a share of the profits earned from the paid premiums and a donation from the contributions of participants. When the insured is still alive on the maturing of the policy – receives the whole amount of premiums, a share of the profit earned from premiums, a bonus and dividends

Non-life insurance The participant is entitled either to the loss that took place or the insurance amount (whichever is less)

Re-Takaful Risk-hedging method whereby Takaful company relied either in a conventional reinsurer or Re- Takaful operator to reinsure risks for cases where risks insured were above the normal underwriting claim. Problems: reinsuring with conventional insurers include issues pertaining to interest and payment of indemnities could also be in conflict with Sharia.

For more information Accounting and Auditing Organization for Islamic Financial Institutions ( Islamic Financial Services Board (

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