Introduction to Islamic Economics & Finance

Characteristics of Islamic Finance

One of the most important characteristics Islamic financing is that is an asset-backed financing. The conventional / capitalist concept of financing is that the banks and financial institutions deal in money and monetary papers only. That is why they are forbidden, Islam does not recognize money as a subject-matter of trade, except in some special cases. Money has no intrinsic utility; it is only a medium of exchange; Each unit of money is 100% equal to another unit of the same denomination, therefore, there is no room for making profit through the exchange of these units inter se. Profit is generated when something having intrinsic utility is sold for money or when different currencies are exchanged, one of another. According to ethical finance, the profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited. Therefore, unlike conventional financial institutions, Islamic finance is always based on illiquid assets which create real assets and inventories.

The real and ideal instruments of financing according Shari’ah laws are Musharakah and Mudarabah. When a financier contributes money on the basis of these two instruments it is bound to be converted into the assets having intrinsic utility. According to Islamic Economics laws, profits are generated through the sale of these real assets. Financing on the basis of Salam and Istisna` also creates real assets. The financier in the case of Salam receives real goods and can make profit by selling them in the market. In the case of istisna`, financing is effected through manufacturing some real assets, as a reward of which the financier earns profit.

Financial leases and Murabahah, are not originally modes of financing. But, in order to meet some needs they have been reshaped in a manner that they can be used as modes of ethical financing, subject to certain conditions, in those sectors where Musharakah, Mudarabah, Salam or Istisna` are not workable for some reasons. (…) Islamic Instruments are clearly distinguishable from the interest-based financing on the following grounds

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