Understanding Islamic Finance - Doha Academy of Tertiary Studies

The Philosophy and Features of Islamic Finance 85to a large extent, depend on how bankers, regulators and Sharī´ah scholars understand theinherent risks arising in these institutions and take appropriate policies to cater for theseneeds. The problems facing Islamic banks, as identified by the survey, include lack of moneymarket instruments and a legal and regulatory framework that is not supportive to them andcould be a source of systemic risk.Mitigation of the risks would require special expertise and sound knowledge of Sharī´ahrules, lest it may lead to non-Sharī´ah compliance. Sharī´ah has identified the responsibilities/liabilitiesof the parties in respect of every contract and one cannot avoid thatresponsibility/liability. Thus, Islamic banks can manage risk to a certain limit beyond whichthey will have to take up the risk/loss. In Ijarah, the risk of asset loss (if not due to anynegligence of the lessee) will be that of the bank, it cannot ask the lessee to bear the riskin addition to paying the rent. 10 The bank will have to bear the cost of managing the risk,although it can build such costs into rentals with the free and mutual consent of the lesseeand subject to related juristic rules. In Mudarabah, the bank, as a Mudarib, cannot get anyremuneration if the Mudarabah business incurs loss.For goods purchased under Salam, the bank can transfer the price and asset risk to anyother party through Parallel Salam. But the responsibility of the original and the parallelcontracts will remain independent of each other. The bank can also mitigate the asset andmarket risk by entering into a promise to purchase by any prospective buyer.Risk of default by clients can be mitigated by putting a penalty clause in the contractto serve as a deterrent; the amount of penalty would go to the Charity Account. This isthe case in all modes except Istisna‘a, where the bank can insert a clause for a decrease inthe price of the asset in case of a delay in delivery. This clause is termed “Shart-e-Jazāi”in Islamic jurisprudence. The logic behind this provision in the case of Istisna‘a is thatmanufacturing/construction of any asset depends, to a large extent, on personal effort,commitment and hard work by the manufacturer, who may start work on contracts withother people, while in the cases of Murabaha and Salam, one party has to pay the deferredliability that has been defined and stipulated in the contract.4.3 DEBT VERSUS EQUITYAfter discussing the basic ingredients of Islamic finance, we take up some related aspectsthat will be helpful in fully understanding the philosophy of Islamic finance theory.It transpires from the above discourse that debt has to remain a part of Islamic finance.Islamic financial institutions, while providing a financial facility through trading activities,create debt that is genuinely shown in their balance sheets. So the issue is not one of “debtversus equity” but one of putting greater reliance on equity and subjecting the debt to theprinciple of Sharī´ah that debt, once created, should not increase on the basis of conventionalopportunity cost theory.In many areas of business, Shirkah-based modes either cannot be used or are not advisable,keeping in mind the risk profile of the investors. For example, a widow may require anIslamic banker to invest her money in less risky but Sharī´ah-compliant business becauseshe is not in a position to bear the risk of loss that could arise in Shirkah-based business.10 This is based on an important juristic rule: Al Ujrah wal Dhamān Lā Tajtami‘ān ( Wage/rent and liability/responsibility do notadd up together).