1. Principles of Islamic Finance

2. The Two Pillars of IF For-profit domain Non-profit domain
A balanced approach

3. Like a bird, an economy needs the two sectors to fly

4. Non-profit Obligations
Zakat
Nafaqat
Sharing in times of necessity, starvation, or hardship

5. Zakat Obligatory donation
Applies to idle money (not used for one year)
Measure against hoarding
Hoarding and the current financial crisis?

6. Nafaqat Obligatory spending for designated relatives
Parents, family, close relatives
Subject to need

7. Why Markets Need Non-profit Actions?
Safety net
Distribution of wealth

8. Why Do We Need Both? Happiness cannot be achieved by one domain
Balance allows both to flourish and thrive

9. For-proft Domain

10. General Principles Prohibition of israf Prohibition of usury or riba
Prohibition of gharar or wagering

11. Israf Over-spending or over-utilization of resources In consumption:
extravagant spending
Conspicuous consumption and status games
In investment:
Greed—”irrational exuberance”
Bubbles => crashes

12. Wealth Preservation
Wealth preservation is an essential objective of Shari’ah
Israf violates preservation of wealth
Results: pollution, global warming, depletion of resources
Essence of economics is to avoid israf

13. Riba

14. Definition Riba or usury: any stipulated addition over a loan
Includes both simple and compound interest

15. Riba Prohibited by all divine religions as well as Buddhism
Two-thirds of world population subscribe to this belief

16. What's Wrong with Riba? Debt grows faster than wealth
Debt cannot be paid except with new debt
Debt burden destroys the economy

17. In 1750 debt equals weight of the globe of gold
1 pence borrowed at 4% in 1 AD
In 1750 debt equals weight of the globe of gold
In 1990 it equals 8190 globes!

18. Debt in the US, $billions

19. Figures Average growth annual rate: Debt-GDP ratio: 1.3 to 2.2
M2: 19%
Debt-GDP ratio: 1.3 to 2.2
Debt-M2 ratio: 2.2 to 4.2

20. Inverted Debt Pyramid
Debt
Wealth

21. Financial Instability
Inverted pyramid is not sustainable
Crashes needed to “clean up” the system
Then debts start to accumulate again faster than wealth
Recurrent crashes
Very costly to maintain the system

22. Restrictions on Debt Theory: Intertemporal Budget Constraint:
The present value of debt go to zero
Prevents Ponzi financing
Reality: E.U. requirements:
Deficit < 3% of GDP
Debt < 60% of GDP
Problem: Need to govern debt from the ground-up

23. Islamic Finance Debt creation is integrated with wealth creation
For-profit debt must be contractually embedded in real transactions
Islamic modes of finance:
Deferred sale; salam; leasing;

24. Deferred Sale Sale of a good for a deferred price
Price includes markup
Time value is paired with real value
Murabaha: Financing deferred sale

25. Salam Opposite of deferred sale Price is spot; good is deferred
Time-value is reflected in lower price

26. Normal Debt Pyramid
Debt
Wealth

27. Gharar

28. Definition Gharar is risk with delusion or deception
Risk: likelihood of loss or failure
Two types of gharar:
Degree of risk
Form of contract

29. Degree of Risk Ex ante measure Gharar if Prob (loss) ≥ Prob (gain)
Example: Lottery
Where is delusion?
Luck vs. skill
Low likelihood of success means low skill
The need for “feasibility studies”

30. Structure of Contract Ex post measure Gharar if it is a zero-sum game
Examples:
Gambling
Sale of a lost car
Sale of a closed box
Why play a zero-sum game?

31. Game Structure
(A , B)
(+ , −)
(− , +)

32. How to Know it is Zero-sum?
A zero-sum game cannot be played if the two parties know in advance who will win
Steps:
Select first outcome
If one player refuses to play, it is a zero-sum outcome
Repeat with other outcomes
If all outcomes are zero-sum, the whole game becomes a zero-sum game

33. Types of Transactions
Zero-sum
Positive-sum
Mixed

34. Positive-sum Deals One party gains only if the other does
Interests are always aligned

35. Partnership (musharakah)
(A , B)
(+ , +)
(− , −)

36. Mixed Games Contains zero-sum and positive-sum outcomes
If the zero-sum outcome is dominant, it is excessive gharar
If not, it is minor gharar
Game acceptable if the positive-sum outcome is dominant

37. Crop-sharing (muzara'ah)
(Land lord , Farmer)
(+ , +)
(+ , −)

38. Relation of Types of Gharar
Zero-sum games are always high risk
High risk deals invite zero-sum games
High-risk: speculation
Zero-sum: gambling

39. Relation of Riba and Gharar
Riba: separates time from real transactions
Gharar: separates risk from real transactions
Time and risk are two sides of the same coin
Riba implies gharar and vise versa
Both allow obligations to grow independent or real wealth => inverted pyramid

40. Conclusion

41. Nature of Islamic Finance
Universal principles
Economic ground
Balanced approach

42. Thank You!