Understanding Islamic Finance - Doha Academy of Tertiary Studies

Overview of Financial Institutions and Products 1858.4.3 Other NBFIsNon-bank financial institutions (NBFIs) other than investment banks are discount houses,leasing companies, venture capital companies, asset management and fund managementcompanies, insurance companies and other specialized institutions for financing varioussectors in an economy. Their activities also pertain to facilitating business and industrythrough direct intermediation between savers and investors and money and capital markettransactions. The investors get interest or a guaranteed dividend while the fund users haveto pay interest. Some NBFIs deal in real estate and manage property and other funds to getfixed and variable returns in the form of interest or dividends.8.4.4 Conventional Financial MarketsFinancial markets facilitate the management of liquidity for investors. When the holder ofthe security needs cash, he can sell the security to a third party via the financial markets. Thepurchaser then steps into the shoes of the previous holder and becomes entitled to receivethe amount.Financial markets in the conventional framework comprise money and capital markets.While the money market is based on receipts and payments of interest on short-term lendingand borrowing and trading in short-term debt instruments, the capital market involvesmedium- and long-term debt and equity-based transactions. Foreign exchange markets areconsidered part of the financial markets.Financial markets are further distributed in the primary and secondary markets. Instrumentsgenerated in the primary market are traded in the secondary market. More recently,global depository receipts (GDRs) – negotiable certificates held in the bank of one countryrepresenting a specific number of securities/shares of a stock traded on an exchange ofanother country – are being traded in the developed financial markets.A conventional bond stands for a loan repayable to the holder in any case, and mostly withinterest. It has nothing to do with the actual business undertaken with the borrowed money.A typical debt market undertakes trading of securities like bonds, debentures, commercialpapers, treasury bills and derivatives in spot and future markets.While debt instruments are entirely based on interest, many joint stock companies involveinterest one way or the other. Either their core business is related to interest or Ghararor they lend or borrow on the basis of interest and undertake Gharar-based activities. Thebasic concept of an equity market, commonly known as a stock market, is permissible underSharī´ah provided the stocks being traded do not involve Riba and Gharar, for which theexperts have developed a number of criteria that we shall discuss in subsequent sections.8.5 THE NEED FOR ISLAMIC BANKS AND NBFISInterest is the cornerstone of the modern financial system. Keeping in mind the strictprohibition of interest in the Islamic framework, one may consider that an Islamic financeand economic system may be developed without intermediaries like banks and financialinstitutions, but this is a misconception. Banks and financial institutions will remain a part andparcel of economics and finance in the Islamic framework as well. Modern businesses needhuge amounts of funds, while people at large have mostly small savings. This necessitatesthe presence of such intermediary institutions through which business needs can be directly