Islamic Financial System IPIEF Week 2 nd

The Concept of Money  Money is essential for the activity of IFIs.  Definitions of money: Based on fiqh, money is synonym of nuqud or tsaman, which is defined as a medium of exchange or transaction as well as a measurement of the value of goods or services. Legally, it’s defined as thing that’s formulated by law as a money. Based on its function, it’s defined as everything that performs the functions of money included as a medium of exchange, a mode of payment, a value store and as a unit of measurement.

The Forms of Money  Full bodied money/commodity money  Fiat money

Commodity Money Has intrinsic value and long lasting Gold and silver Applied in the Islamic State period In the next development, modified as a gold reserve standard paper money supported by gold and silver printed only if gold/silver is provided gold standard

Fiat Money  Paper money  Not supported by commodity  Only supported by government policy  Managed money standard  Government responsible for the maintaining of the paper value  The paper its self has no value actually

Forms of Fiat Money  Cash  Non cash Discussion in depth provided in the macro economic subject

Financial System  Subsystem of economic system;  Allows the transfer of money between savers and borrowers;  Comprises a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions.

The Importance of Financial System  Crucial to the allocation of resources in a modern economy;  Channels household savings to the corporate sector and allocate investment funds among firms;  Allows inter temporal smoothing of consumption by households and expenditures by firms;  Enables households and firms to share risks  Has impact on saving, investment, technology innovation, and economic development;  Controlling and monitoring managers of firms.

Islamic Financial System  A set of rules and laws, collectively referred to as shariah, governing economic, social, political, and cultural aspects of Islamic societies (Iqbal, 1997);  Comprises of: Islamic Financial Instruments Islamic Financial Institutions Islamic Financial Rules and Regulations Islamic Financial Control and Supervision

Basic Principles of Islamic Financial System  Syar’i principles Based on Al Qur’an and As Sunnah  Tabi’i principles Based on the ijtihad and ijma’ Related to contemporary issues such as risk management, cash flow management, technical analysis, capital management and so forth.

Syar’i principles  Prohibition of interest (riba)  Prohibition of speculative behavior (maisir)  Prohibition of uncertainty (gharar)  Risk sharing between suppliers of fund (investor) and enterpreneur  Money as “potential” capital Money becomes actual capital only when it joins hands with other resources to undertake a productive activity time value of money, only when it acts as capital, not when it is “potential” capital.  Sanctity of contracts Disclosure of information and upholding the obligation contract is sacred duty To reduce information asymmetric and moral hazard  Shariah-approved activities

Riba  Usury  Excess, increase or addition  Types: Riba Al Buyu’ Riba Al qard Riba Al Jahiliyah Riba Al Fadhl Riba Al Nasa Riba Al Nasia

Riba Al Buyu’  Usury of trade  Referring to instances where the usury is achieved through a trading transaction as opposed to a loan transaction

Riba Al Qard  Usury on a loan  Analogous to the charging of interest on the loan of an asset  Any excess for precondition to the borrower

Riba Al Jahiliyah  The kind of usury practised during the pre-Islamic times among the Arabs  Involving a delay in payment of a debt in return for an increase in its amount  Debt payment above the actual amount of the debt because the debtor fails to pay on time

Riba Al Fadhl  Usury of surplus  The usury is achieved through an unequal exchange of quality or quantity  An exchange of unequal qualities or quantities of the same commodity simultaneously  The exchange of ribawi commodities at the different quality and or quantity

Riba Nasa  Usury of postponement  A form of usury in which an exchange of two equal qualities or quantities occurs, but where the exchange is not completed on the spot (i.e. hand to hand).  There is thus a postponement in the completion of the exchange.  The term is sometimes used interchangeably with 'riba al-nasia'

Riba Nasia  Usury of waiting  Used variously by scholars: some regarding it as being that usury which is achieved solely by effecting a delay in the exchange of two countervalues in a transaction others regarding it as a combination of riba al- fadl and riba al-nasa thus giving rise to both a delay and an unequal exchange of quality or quality  Differences/excess/additional to the exchanged commodity because of the different time of delivery/payment

The Implication of Riba to the Sale and Purchase Transaction  Sale and purchase of similar ribawi commodities should be performed at the same quantity and quality and must be hand to hand.  Sale and purchase of different ribawi commodities at the different quantity and quality is permissible but it should be performed on the spot.  The exchange of ribawi commodities to non ribawi commodities may not be at the same quantitiy as well as quality. The commodities should be transferred at the same time of aqad.  The exchange of non ribawi commodities at the different quality and quantity is permissible but must be deliverd on the spot.

Characteristics of Islamic Financial System Chapra (2000)  To achieve the economic welfare through utilizing resources efficiently; Without producing unlawful product Without great gap between the poor and the rich (Equitable distribution) Without harming current/next generation as well as environment  Stability of currency value  Mobilization of saving investment to encourage productive activity  To provide effective financial services.