Mufti Ismail Ebrahim Desai
Global Islamic Financial Services Firm
Islamic banks and financial institutions offer business and commercial finance solutions that are Shariah compliant. Imagine a bank that funds your suppliers and creditors for a fixed maturity term in a Shariah-compliant manner. The bank never offers a conventional loan repayable with interest. You simply purchase your raw material and goods from the bank with a mark up.
It may be argued that charging rent or making a profit is no different than charging interest, in that ultimately the providers still makes money. But remember that the Islamic banks do not lend money for profit, as that is interest. Instead, Islamic banks purchase the actual assets and then either lease, sell or partner with the client. Therefore, the bank is legitimately allowed to profiteer on such basis. Instead of making money through interest, Islamic banks make money through profit or through rent when the bank owns the property as an asset. It is important to remember that Islamic business financing simply offers an alternative financing structure, which gives Muslim customers different options to fund their businesses in a Shariah-compliant manner.
Islamic business financing solutions in an entrepreneurial community like South Africa have been largely limited and out of reach for many aspiring and growing businesses. There are many products and mechanisms for Shariah-complaint businesses and commercial finance, but it may be difficult and confusing to understand the fundamental elements and concepts underpinning such products.
There are various Shariah mechanisms used for Islamic businesses and commercial finance: Musharaka, which means 'partnership;’ and Murabaha, meaning 'profit;’ Ijara, which means ‘leasing;’ and Mudaraba, which means ‘sweat partnership.’ Depending on the model, the bank will add profit to the amount you pay back instead of charging interest. Shariah products are not loans similar to conventional loans payable on interest. Islamic banks and finance houses engage in actual trade.
Mudaraba: This form of finance is rarely offered by Islamic banks and is a mechanism by which capital and labor are brought together to achieve a harmonious and profitable end. It means the capital provider is providing the funding to an entrepreneur possessed of specific skills and ideas needed to run a profitable business. The capital provider (rabb-ul-mal) may invest through the entrepreneur (mudarib) needing the start-up funds.
Islam clearly states that capital as a factor of production deserves to be rewarded. It allows the owners of capital a share in the surplus, although the amount of surplus is uncertain and there is an element of risk involved. In the context of Shariah, investors cannot demand a fixed rate of return for their investment and therefore, every case is examined by a Shariah advisor to ensure that it is eligible, and to calculate repayments of capital and the share of profit. This is done both before the investment is made, and at regular intervals thereafter.
Ijara or Leasing System: This is a leasing agreement. Under this model, the provider of capital buys capital equipment and leases it to its customers who may opt to buy the items eventually. In effect, the monthly payments will consist of two components: i) rental for the use of the equipment and ii) installments towards the purchase price.
Musharaka: This is financing through equity participation between various organizations, shareholders or partners. The partners use their capital through a joint venture or a limited partnership in order to generate a profit. This profit will be split among the shareholders according to a pre-agreed formula that is dependent on the amount of investment that each party puts in.
This financial instrument can be used in venture capital financing and is less risky to all the parties involved. In effect, all the partners must come with some form of capital rather than just their skills; this instrument will, therefore, not be applicable to a credit union where entrepreneurs have little or no capital to bring into the relationship.
Murabaha: There is usually a physical commodity traded in a Murabaha transaction. For example, a bank will finance the purchase of an asset by buying it and selling it to the client for a profit. The price can then be paid in cash, installment or deferred. The bank is between the buyer and the supplier, and is liable if anything goes wrong prior to selling the asset to the client. Title of the goods passes onto the bank’s client upon sale completion. However, the registered title may be mortgaged in favor of the bank as a security for a deferred payment. The bank utilizes its own funds to open the letter of credit. Murabaha is the most widely used Islamic trade finance product.
Other Shariah Products
Here is a list of Shariah products currently offered to fulfil various business demands and needs:
Ensuring Compliance at All Stages
It is extremely important that the bank and client ensure that all the relevant stages in executing the above contracts are duly followed. Any default in following the proper sequence set out will render the transaction invalid. While many individuals sign up for such financing products, they must ensure that the terms and conditions, contracts and implementation of such documentation are also Shariah compliant.
This material is for informational purposes only. It is not intended to provide any investment advice or provide the basis for any financial decisions. You should seek the advice of your financial adviser, legal or tax professional, prior to making any investment decision. Any links to third-party websites are provided strictly as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites nor do we endorse the content and information contained on those sites. When you access one of these websites, you are leaving our website and assume total responsibility and risk for your use of the third-party websites.
Wahed publishes content on this blog that has been created by third-party sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Unless otherwise noted, the views and opinions expressed in posts on this blog are those of the authors and do not necessarily reflect the official policy or position of Wahed or any of its officers, directors, or employees.
Note: No Articles published on this website shall be reproduced in any form without the prior written permission of Wahed Invest.