Understanding Islamic Finance - Doha Academy of Tertiary Studies

82 Understanding Islamic FinanceThe principle is that ownership cannot be separated from the risk of related loss. This hasimportant implications for various transactions. In loans, there is no entitlement to any profitbecause the creditor gets back the full amount, irrespective of the nature of use by the debtoror the fact the debtor incurred loss in his business which he undertook with the borrowedmoney. In trade, so long as the asset remains with the seller, he has to bear the risk of itsdestruction; as soon as he sells it, the risk is transferred to the buyer and in the case of acredit sale, the buyer has to pay the price at the settled time even if the asset is destroyedfor any reason. He can mitigate the risk by way of Takaful but it will have no link with hisliability to pay the price. In Ijarah, the lessor is entitled to rent only when he keeps the assetin usable form by incurring ownership-related expenses and undertakes the risks associatedwith the asset.The business risk involved in Shirkah-based modes is far more than that involved intrading modes like Murabaha, Salam and Ijarah, because in Shirkah, all business loss hasto be borne by the capital while the manager or the entrepreneur loses his labour in thecase of loss in a joint business. For depositors in Islamic banks, risk stems from the failureof business and uncertainty regarding the level of profit to be shared. This risk does notdiscourage depositors; rather it justifies the profit and as such we see that Islamic banks’deposits are increasing continuously. For banks, financing on the basis of Shirkah involvesrisk because clients could disguise the profits and they may lose even the principal, becauseloss in Islamic finance means loss of capital and not any decrease in the expected profit.Although investment depositors participate in PLS, there arises the question of whetherthey should bear only the market risks or also the risks related to fraud, carelessness,mismanagement and loan concentration. There is, however, a consensus that the depositorsshould not be burdened on account of negligence and follies on behalf of the management.Experts consider it desirable to protect them against these risks to raise their confidencein the financial system and to make the banks’ management as well as the supervisoryauthorities more careful in their risk management and regulation of the banks respectively.4.2.7 Islamic Banks Dealing in Goods not in MoneyConventional banks deal in money: they get money from the public as loans and pay theminterest; they give advances to needy people or firms in the form of money and charge theminterest. In domestic or foreign trade financing activities or even in the case of finance lease,goods are also involved, but they have no concern with the goods or assets themselves; theirmain concern is with financing the purchase of goods and for that purpose they also deal indocuments to facilitate the trading of goods. As such, there is a famous quote in conventionalbanking: “Banks deal in documents not in goods”. They undertake no responsibility or riskin respect of the subject of the contracts and their counter payments or price.In contrast, Islamic banks deal in goods and documents and not in money. They usemoney only as a medium of exchange for purchasing the goods for the purpose of leasing orselling onward, thereby earning income or profit. In this process they also use documents forexecuting sale and lease contracts, keeping in mind the Sharī´ah principles and facilitatingthe operations.The above discussion reveals that Islamic banks intermediate between savers/investorsand fund users by involving certain goods and assets or papers representing ownership ofreal assets. In Salam or Murabaha, for example, the banks deal in certain commodities,not money. They purchase the goods directly or through their agent (under a Wakalah