How Much Do You Know About Islamic Finance?

In partnership with: 

Don’t know riba from gharar and maysir? Don’t worry, we have you covered.

Islamic financing is on the rise, as practitioners of Islam, who currently make up more than 24% of the global population, are also the fastest-growing religious demographic worldwide, due to a combination of high fertility rates and a younger median age (24 years in 2015) relative to non-Muslims (32 years), according to the Washington, DC-based Pew Research Center.

Despite this, awareness of Islamic financing models and how they differ from conventional financing has room to improve in Malaysia, despite its demographics and predominant faith. As such, an exploration of the field has much to offer investors as a whole while educating those looking for the right financial instrument to suit their needs. Today, we sit down with noted author/trainer Hajjah Zarinah Mohd Yusoff to discuss the matter.

A Different Perspective

“The main differences between Islamic finance and conventional finance are the underlying contracts used in structuring the Islamic finance products and the scope of businesses that Islamic financial institutions are allowed to involve,” she says.

Author/trainer Hajjah Zarinah Mohd Yusoff (source: www.smartinvestor.com.my)

These prohibitions of riba, gharar and maysir are the main reasons for the use of a variety of business contracts in structuring Islamic financial products. In conventional banking, all activities are based on interest. This is riba or usury in lending, which is prohibited in Islam, as it is considered as an injustice to the borrower, as the lender takes benefit from the borrower freely.

Due to the prohibition of riba, Islamic banks – as commercial entities – must undertake business activities such as trading and leasing. Meanwhile, the prohibition on gharar is designed to uphold justice between contracting parties. Gharar refers to ambiguity or uncertainty. In business transactions, it can arise from ambiguous contracts; for example, unspecified prices and terms of payment, unclear specifications on the subject matter and unidentified contracting parties.

In Islamic finance, to avoid gharar, details regarding price and terms of payment, subject matter and the contracting parties have to be clear and specific. This is to minimise unnecessary risks, which might lead to injustice for the contracting parties.

“Meanwhile, maysir means gambling, which might arise from excessive risks. In conventional finance, activities like derivative and forex trading can expose institutions to excessive risks. That is why some derivative products are not shariah-compliant, and thus, are prohibited for Islamic financial institutions,” says Hajjah Zarinah.

In terms of business scope, on top of businesses that have elements of riba, gharar and maysir, Islamic financial institutions are also prohibited from involving themselves with businesses associated with shariah non-compliant products like the production of liquor, rearing of pigs and production of pig-based food, the planting of tobacco and production of tobacco products.

Islamic finance in Malaysia features a product range which nearly mirrors the offerings in the conventional market. The two segments are set to grow in tandem, particularly with concerted efforts among industry players, product operators and intermediaries.

In addition, consultants now have greater awareness of the importance of providing advice to clients. Hence, many are pursuing professional qualifications like IFP and Shariah Registered Financial Planner (RFP) status, in their efforts to obtain licensing from Bank Negara Malaysia and Securities Commission (SC) Malaysia.

The article is contributed by Aliff Yusri from Smart Investor. Smart Investor is the country’s leading monthly investment magazine. It focuses on enhancing value for both retail and institutional investors via its extensive corporate and financial commentaries and features.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect those of CompareHero.my