Introduction - Euromoney Institutional Investor PLC

Copyright of Euromoney Institutional Investorrental income from a building the owner must assume responsibilities for the externalmaintenance of the building as with an ijara operating lease.Profit is also seen as a justifiable reward in Islamic finance, which rather than beingrelated to work or ownership, is compensation for risk sharing. In business and financethere are always risks including credit, market and operational risk, but if risks are sharedbetween the parties this is more just than simply assigning all the risk to a single party.With conventional lending the borrower assumes all the risk, and is penalised further forpayment delays or defaults. In contrast in Islamic finance the risks are shared between thebank and the client. Of course Islamic banks have to manage credit risk, andunscrupulous defaulters should not be treated leniently, otherwise moral hazard problemsmight arise.Misselling of financing products is clearly immoral, as with the sub-prime mortgages inthe United States and to a lesser extent the United Kingdom, where borrowers wereencouraged to take on debts they could not afford by mortgage brokers and bank salesteams who earned up-front fees for each mortgage sold. When the inevitable defaultsoccurred this was of no concern to the mortgage brokers and sales teams who had movedon to other activities. Islamic banks have to adopt fair and transparent charging structureswhich do not exploit the ignorance of the client. Their staff must ensure as far as possiblethat clients can meet their financial obligations. So far the record of Islamic homefinancing has been favourable, with none of the defaults that have characterised the subprimecrisis.Islamic finance is inherently participatory with the financier getting involved with theclient and taking an interest in how the funding is utilised. This is not only to ensure thefinancing is serving a moral purpose, although that is important, but also to help the clientmanage the funds received effectively. The financier can act as an agent for the client, aswith murabahah where the financier purchases a good on behalf of the client and re-sellsit to the client for a mark-up which makes the transaction profitable. What justifies themark-up is the ownership responsibilities exercised by the bank, which serves as a trader4