Islamic Finance in Practice
Theories of Motivation
Islamic finance primarily means any establishment of financial resources which is governed by Sharia law (Ben Naceur, Barajas, and Massara, 2015). As regards the nature and methods of financing, in principle, any financing technique respecting the prohibition of interest and speculation is acceptable. These rules lay the foundation for the Islamic financial system, with the alternative being crowdfunding based on profit sharing and risk of loss.
We observe, however, that Muslim economists, lawyers, and financiers, after a century of breaking away from their legal heritage, have had to face the need to devise Islamic alternatives to interest-rate financing. Islamic banks and Islamic subsidiaries of traditional banks have thus designed legal and financial mechanisms which are based on concepts called mudaraba, mousharaka, mourabaha, and ijara …
Financing “with participation.”
The first type of financing is based on the principle of profit and loss sharing. In one case, the bank is content to provide financial capital to the entrepreneur.
This is referred to as a moudaraba, a passive partnership contract akin to the operation of a limited partnership in our traditional financial system. Indeed, the bank (the donor partner) has no say in the project’s management. In the event of failure, the bank bears the capital loss (Munawar & Moyneux, 2005).
Conversely, in the case of a Mousharika, the bank can intervene in project management. By virtue of its operating methods, this active partnership between the entrepreneur and the bank is similar to a joint venture commonly encountered in traditional finance. In the event of failure, the loss is borne by all the partners (at least two) according to the capital contribution previously made by each (DiVanna, 2006).
Financing “without participation.”
“Non-participating” transactions mainly concern transactions of a commercial nature (purchase or sale of assets). Murabaha and ijara are the most widely used contracts.
The first is a sales contract subject to specific clauses resulting from the principles set out in Sharia law. The sale must be instantaneous, the item sold lawful, and its price clearly displayed and justified. Such a type of binding can also be used as a source of financing. In this case, the Islamic bank acts as a financial medium between the buyer and the seller. In effect, the bank buys a good in cash on behalf of a customer and then resells it at a price plus a profit margin.
The ijara is like a conventional finance lease or rental agreement. Unlike the Murabaha, this type of contract transfers the usufruct of the property, that is to say, the right to use it, and not its entire property (Dar & Azami, 2012).
