Islamic Finance: A Favorite Investment choice

Thanks to its rich oil and gas resources and huge amounts of money, have their own unique business rules of the Islamic financial industry in the ascendant.

U.S. sub-prime mortgage crisis, the clouds dispersed, the global financial market volatility in Europe and the United States and emerging market stocks have plummeted  At this moment, Islamic finance, a people unfamiliar area, due to low correlation with global markets, is gradually becoming a body the new darling of investors.

The early 20th century, with the colonization of the Western world, commercial banks to manipulate the financial activities of the Islamic world, free of interest charge, which with the “Koran” anathema to the teachings. Although some Muslim merchants were forced to participate in interest trading, but still had the moral sense of guilt. To overcome this predicament of conscience, special set up to follow the principles of Islamic finance, Islamic banks to compete with traditional commercial banks.

Islamic financial activities began in the 20th century, 50 years of Pakistan, and then quickly spread to the Arab world. However, the rapid expansion of Islamic banks is the oil-exporting countries benefited from the large current account surplus. The Islamic banking industry has also been encouraged by the government. 70 years, there has been a famous Dubai Islamic Bank, Saudi Arabia’s Islamic Development Bank, Kuwait’s financial community has significant funding and a number of Islamic banks. Now, almost all Islamic countries have established some form of Islamic banking. In addition, in some European countries there have been some Islamic financial institutions or offices. Islamic finance is not limited to Islamic countries, but are located in each of a large Muslim community. Today, Islamic banks have been more than 300 in over 70 countries, the banks had total assets of more than 5000 billion U.S. dollars, sales increased from 2003 to eight billion U.S. dollars has rapidly risen to 700 billion U.S. dollars in 2010 is expected to reach 140 billion U.S. dollars. Although the international market share of Islamic finance is still relatively small, but the annual growth rate is as high as 15%.


What are the Uniqueness of Islamic Finance

The Islamic financial system is simply described as “passive” and does not reflect the true face of the system. There is no doubt that the core of the Islamic financial system is to prohibit the collection and payment of interest, but it was the teachings of Islam advocated by other principles which are mutually reinforcing, such as risk-sharing, individual rights and responsibilities, property rights and the sanctity of contracts and so on, stressed that the capital must be involved in the actual economic production activities, emphasizing equitable distribution of wealth, and investment companies have to comply with the principles of social ethics.

With an emphasis on cost and profit compared to the Western financial system, Islamic financial system, undoubtedly added more colors of the social welfare. Islamic finance is only engaged in business activities in line with Islamic teachings, to engage in, such as alcoholism, speculation, weapons, tobacco, pork, gambling, involving humans, animals, genetic engineering, biotechnology companies and other activities to avoid any connection to any investment.

Islamic finance speculative activities prohibited on the high-risk investments have certain limitations. The Islamic financial system is not limited to banking, but also covers capital formation, capital markets, as well as all types of financial intermediation.

All the Islamic financial products are not of interest – whether the charging of interest or the interest payments. Investment is as a lease arrangement, or will invest the money to a third party trustee, which he and the Islamic depositors revenue-sharing.

The Islamic financial system has mainly taken the following forms:

Profit and loss sharing system (Mudalaba system) to promote such a system between banks and customers (depositors), in partnership, both sides share the profit and loss operation. Customers in the bank, they amount of money and deposits in accordance with its terms of profit and loss sharing agreement reached with the bank, that is, the profits of banks from two to share, operating losses that occur are also shared by two. At the same time, bank loans, also introduced from outside profit and loss sharing the proceeds of bank loans is also directly with the borrower to use the funds associated with operating conditions.

Murabaha system in which banks in financing trade, to obtain income from the mark-up rate. For example: customer needs bank financing to buy for him what he needs, after which time a one-time customer or by the bank to repay debt, or installment payments to the bank, or some sort of agreement reached by both sides. In either case, after a period of time, the customer paid the money the bank higher than the original item price, the difference of which is the bank’s earnings.

Fee system, many Islamic banks in the prohibition of interest at the same time, allowing loans charge a fee. Fee is the bank staff in handling loan business in the remuneration of labor costs. Fee is fixed.

In short, sources of funds, banks offer Islamic deposits (security of this type and investment-type) as the Islam of the investment pipeline. Use of funds, the provision of cost plus profit sale, lease contracts, equity participation, profit-sharing and other financial instruments in order to provide consumers to buy houses, cars and business revolving loans.In addition to banks, there are a number of Islamic investment companies to provide Shariah-compliant investment and growth funds. At present, the world’s more common Islamic financial instruments and the Islamic Foundation of Islamic bonds, the former Soviet Union (Sukuk) dominated; while the latter’s investment is required in accordance with Islamic investment principles, investment in approved by the teachings of Islamic investment products . The Islamic investors to look at investment projects in the past, when the first consider the teachings of Islam, if not inconsistent with the teachings of investment; now when you look at the return on their investment, if the return on high, they are changing the investment products to conform to doctrine after the investment. The current investment required is relatively flexible and flexible. For example, Islam forbids drinking alcohol, but they can invest in the hotel, if the hotel have a bar, that bar investment and income must be and hotel separately.

The transfer of investment from west to east

 The Islamic investors to put money into the past, to Europe and the United States, with the depreciation of U.S. dollar, they put the money into the Middle East and Asia. However, they invest in financial products generally are more real estate. They are investing in Asia, there are several different modes: one is the private equity fund, private equity funds and they are directly owns the land; There is also a model of the Islamic-style loans. For example I want to buy a car, the price 200,000. Bank to buy the car, and then in the form of a lease car so that I use, lease period of five years, the rental fee is 400,000. 5-year period, car ownership to be me, more out of 200,000 is actually interest, but is different. Another real estate fund. Islamic fund to invest in a place that the risk is relatively high, should be to invest in different areas in order to share the risk. The Islamic funds are now invested in different real estate.

Islamic finance is becoming a new platform for financial markets. Many countries promote their rich Islamic financial products, and strive to Islamic financial center. Malaysia itself as the financial holy Muslim. Almost every Gulf countries, especially Saudi Arabia and the UAE are all striving to become the Middle East financial center. As a veteran international financial center, the United Kingdom, trying to become a global Islamic financial center. Japanese financial institutions also make significant inroads into Islamic finance, Japan joined the Islamic Financial Services Board (IFSB), preparation for the issuance of Islamic bonds, and the establishment of Islamic insurance. Japan’s move a clear objective, directed at the Islamic country’s oil wealth.

Current And Future Challenges In Islamic Finance

This is an extract of the report Planning Committee on Financial Institutions Japan

Director, Division Yamasaki Toshikuni at Keidanren Kaikan, Otemachi, Tokyo, and invited the Director of the Bank for International Cooperation Maeda Masashi financial capital, heard about the current and future challenges of Islamic finance in Japan

On the tenets of Islam, and equate the interest is unearned income (Riba) are forbidden to be taken will be made to take the form of the loan sale and lease on the facts. In addition, expanding around the world to Malaysia and the Middle East now that the market is said to be the one that has exceeded a trillion dollars. The most basic form of “lava waste” is a summary of the investor funds, increasing operating profits by investing the funds to the employer how to take it back to the investors as dividends. Because of the dividends received by investors because of investment management companies necessarily match those of Reforms to ban the Riba, and the reason is that Sharia should disqualify.

However, in Japan, because the bank could not do business products such as spot trading, Islamic finance could not handle. However, the revised Financial Instruments and Exchange Law is pending in the regular session, after banks and insurance companies can be revealed by the company with his brother, a subsidiary of the same committee about the future for Islamic finance What was the exchange of opinions. Director Maeda, Islamic finance these developments, the original is said to be the retail heart of the Muslims. For example, in Britain is not an  Islamic state, but long-term residents because many Muslim residents in England and the Financial Services Agency is studying early Islamic finance, equal to that of normal competitive conditions in the financial and Islamic finance said he also proceed from the perspective of institutional arrangements.

In addition, explained that Malaysia has contributed significantly to the expansion of this world of Islamic finance. The country’s Islamic financial laws enacted from 1980’s, developing and delivering innovative Islamic financial products, Global 2002 and the first that was issued Soburinsukuku, as do the promotion of Islamic finance as a national goal , Bank Negara Malaysia (central bank) the MIFC initiative (Plan of the Islamic International Financial Center, Malaysia) was introduced that has adopted the.

The Sukuk has a particular focus on Malaysia (Islamic bonds) and the ever-increasing growth in the issuance of itself, and recently received a 30 and was issued to raise a billion Sukuk, the Islamic Government of Malaysia issued A bond rating from BBB also went up and said.

Therefore, the impact of oil money often discussed the relationship is strictly indirect, government investment funds that are directly operated by the oil money in excess of the monetary approach to Islam is that not think the distinction should be pointed out.

Director Maeda, in contrast, shows the view on many issues and will develop Islamic finance in Japan in the future. First, the standard interpretation of the Shari’a Board to determine whether a constant, not necessarily conform to the Sharia, said the status quo tend to be more stringent than that of products such as non-Muslim country of Japan. In addition, Japan has few Muslims, and is unlikely to challenge the demand for retail point.

So, if you work on a new Islamic financial institutions in Japan next, Takaful companies in Japan have already achieved a certain level (Islamic insurance), and we think it is appropriate to start operations in Sukukuarenja said.

In addition, the leading Islamic financial terms, and it should have entered a partnership with Europe and cooperation with Malaysia and have a track record to launch a joint venture to form the framework topper made to foreign partners and also good.

From participants and interpret the reality of Sharia board had a question about the notes continue to improve the tax system on the Cabinet Office and the Financial Instruments and Exchange Law pertaining to the future.

In contrast, Maeda Department can promote the standardization of eligibility decisions by Shari’a Shari’a Board is easy, but in Malaysia, for example, Sharia law, including by foreign examination and registration system with advanced pre-screening and other initiatives that we do make the Sharia Committee, the international organization headquartered in Bahrain AAOIFI (Auditing and Accounting Organization of Islamic Finance Authority) said that such efforts have been interpreted by the criteria. Also, consider hanging a long time about the tax treatment in the UK as well as non-Muslim country, it gradually after the improvement has been institutionalized, to be made in institutional development is still time consuming said matter.

Source : keidanren

Financing Through Musharaka: Principles And Application



Virtually unknown three decades ago, Islamic financing is now practiced around the world. Since its official launch in the 1970’s, Islamic financial institutions have witnessed rapid international growth in both Muslim and Non-Muslim countries (Dudley 2001).

Although the concept of Islamic finance has existed for centuries, it only came into prominence during the last century (De Jonge 1996, p.3). The first successful application of Islamic finance was undertaken in 1963 by Egypt’s Mit Ghamr Savings Banks, which earned its income from profit-sharing investments rather than from interest (Lewis & Algaoud 2001, p.5). By the 1970’s, the push for Islamic finance had gained momentum. In 1973 the conference of foreign ministers of Muslim countries decided to establish the Islamic Development Bank with the aim of fostering  the economic development and social progress of Muslim countries in accordance with the principles of Shari’ah (Saeed 1996, p.13). This marked the first major step taken by Muslim governments in promoting Islamic finance.

Shari’ah law (Islamic law based on the teachings of the Koran) prohibits the followers of Islam from conducting any business involving Riba (interest). This means that Muslims cannot receive or pay interest, and they are, therefore, unable to conduct business with conventional financial institutions (Jaffe 2002). The creation of Islamic financial institutions came about as a method for servicing this niche market.

In order to compete with conventional modes of financing (interest-based financial instruments), Islamic financial institutions developed products that would fulfill  the Shari’ah obligation and provide the same value as conventional bank products (Malaysian Business 2001). The main Islamic financial products include profit-and-loss sharing (Mudaraba and Musharaka), cost plus mark-up, and leasing. The focus of this article is to analyze the profit-and-loss sharing instrument of Musharaka and the way it is implemented. The article begins by briefly describing the profit-and-loss sharing system, followed by a detailed analysis of Musharaka. The article then looks at the application of Musharaka as a home financing instrument, and concludes by analyzing the current issues affecting Musharaka, and the criticism leveled against it


 Profit and Loss  sharing system


Although Islam excludes interest earnings from financial activities, it does not necessarily mean that the financier cannot earn a profit. In order to do so, the financier has to ensure that gains made on the original amount are directly related to the risk undertaken on the investment (Siddiqui 1987). If there is no risk involved, the gains made represent interest rather than profit.

In order to understand how the Islamic system differentiates between profit and interest, one has to look at the differences in the economic ideology. In a capitalist system, capital and entrepreneurs are treated as two separate factors of production. The return on capital is interest, whereas the entrepreneur, who risks losing money, earns a profit. While interest is a fixed return for providing capital, profit can only be earned after distributing the fixed return to land, labor and capital (in the form of rent, wage and interest). Thus, the capitalist system seems to favor those who lend capital to entrepreneurs by providing them a secure return, entrepreneurs bear the risks of incurring losses and still making interest payments on borrowed capital.

In comparison, Islamic economic system does not consider providers of capital and entrepreneurship as separate factors of production. It believes that every person who contributes capital in the form of money to a business venture assumes the risk of loss and therefore is entitled to a proportional share in the actual profit (Siddiqui 1994, p.99). The system is protective of the entrepreneur, who in a capitalist economy would have to make fixed interest repayments even when the venture is losing money.  (Usmani, M.I. 2002, p.13). Capital has an intrinsic element of entrepreneurship, so far as the risk of the business is concerned and,  therefore, instead of a fixed return as interest, it derives profit. The greater is the profit earned by a  business,  the higher the return on capital will be. With no fixed interest repayments, profit in an Islamic economic system would be higher than in the capitalist economy. The system ensures that profits generated by commercial activities in the society are distributed equally amongst those who have contributed capital to the enterprise.

Another difference between the two economic systems lies in the way money is used. In economic terms money has no intrinsic value; it is only a medium of exchange, therefore, earning interest on a medium of exchange without bearing any risks does not sit well in the Islamic system (Rahman 1994, p.14). Islamic financing is, therefore, an asset-backed financing. When a financier contributes money on the basis of the profit-and-loss sharing instruments, it is bound to be converted into assets having intrinsic value (Usmani, M.T. 1998, p.19).

The profit-and-loss sharing system has its roots in the ancient form of financing practiced by Arabs since long before the advent of Islam. After the introduction of Islam, this system was permitted to continue and was legitimatized as a finance instrument. For this historical reason, scholars consider profit-and-loss sharing financial instruments to be the most authentic and most promising form of Islamic contracts (Ariff, 1982). Mudaraba (finance trusteeship) and Musharaka (equity partnership) are two such financial instruments based on the profit-and-loss sharing system, where instead of lending money to an entrepreneur at a fixed rate of return, the financier shares in the venture’s profits and losses (The Economist 2001).




The literal meaning of the word Musharaka is sharing. Under Islamic law, Musharaka refers to a joint partnership where two or more persons combine either their capital or labor, forming a  business in which all partners share the profit according to a specific ratio, while the loss is shared according to the ratio of the contribution (Usmani, M.I. 2002, p.87). It is based on a mutual contract, and, therefore, it needs to have the following features to enable it to be valid:

  • Parties should be capable of entering into a contract (that is, they should be of  legal age).
  • The contract must take place with the free consent of the parties (without any duress).

In Musharaka, every partner has a right to take part in the management, and to work for it (Gafoor 1996). However, the partners may agree upon a condition where the management is carried out by one of them, and no other partner works for the Musharaka. In such a case the “sleeping” (silent) partner shall be entitled to the profit only to the extent of his investment, and the ratio of profit allocated to him should not exceed the relative size of his investment in the business.

However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all matters of business, and work done by any of them in the normal course of business shall be deemed as being authorized by all partners (Usmani, M.I. 2002, p.92).

Musharaka can take the form of an unlimited, unrestricted, and equal partnership in which the partners enjoy complete equality in the areas of capital, management, and right of disposition. Each partner is both the agent and guarantor of the other. Another more limited investment partnership is also available. This type of partnership occurs when two or more parties contribute to a capital fund, either with money, contributions in kind, or labor. Each partner is only the agent and not the guarantor of his partner. For both forms, the partners share profits in an agreed  upon manner and bear losses in proportion to the size of their capital contributions (Lewis & Algaoud 2001, p. 43).

‘Interest’ predetermines a fixed rate of return on a loan advanced by the financier irrespective of the profit earned or loss suffered by the debtor, while Musharaka does not envisage a fixed rate of return. Rather, the return in Musharaka is based on the actual profit earned by the joint venture. The presence of risk in Musharaka makes it acceptable as an Islamic financing instrument. The financier in an interest-bearing loan cannot suffer loss, while the financier in Musharaka can suffer loss if the joint venture fails to produce fruits (Usmani, M.T. 1998, p. 27).

Musharak in home financing


When used in home financing, Musharaka is applied as a diminishing partnership. In home financing, the customer forms a partnership with the financial institution for the purchase of a property (Saeed 2001). The financial institution rents out their part of the property to the client and receives compensation in the form of rent, which is based on a mutually agreed fair market value. Any amount paid above the rental value increases the share of the customer in the property and reduces the share of the financial institution.

The application of diminishing Musharaka in home financing can be illustrated with the help of the following example, which the LaRiba bank in the U.S. follows:

Let us assume that a potential buyer is interested in purchasing a home worth $150,000. The buyer approaches an Islamic financial institution for the purchase of the property and puts 20 per cent of the price ($30,000) as down payment (the down payment required differs between financial institutions. In some cases it is as low as 5 percent ). The financial institution pays for the other 80 per cent of the price ($120,000). This agreement results in 20 per cent of the home ownership belonging to the client and the remaining 80 percent to the financial institution.

The next step for both parties would be to determine the fair rental value for the property. One way to determine the rental value is for both the client and financial institution to survey the market to obtain estimates for similar properties in the same neighborhood and negotiate an agreement. This fair rental value will remain constant over the life of the agreement. For this example, we will assume $1,000 per month as the rental value.

A rental value of $1,000 means that the client will pay $800 as rent for the 80 per cent share the financial institution holds. The two parties then agree on the period of financing. In this example we will assume that the financing period is 15 years (180 months). Based on the rental value and the financing period, the financial institution then determines the fixed monthly payments the client would have to make to own the house. 

Table 1

Example of payment schedule for a home-loan under Musharaka.

Month Rent $ Extra Payment $ Total Fixed Payments $ Bank’s Ownership $









































In this example the client starts by paying $1147, which includes the required 80% of the $1,000, and extra payment of $347. By doing so the client reduces the share of the financial institution by $347, and increases their own share by the same amount. The next month’s rental payment of the client would be reduced to $798, and again the payment made above the rent amount will result in an increase in the client’s ownership of the property. This continues on till the client buys back all the shares of the home that the financial institution holds at the end of the agreed financing period.

This example does not take into account fees and charges that the financial institution may charge such as insurance and taxes.

In the event of non-payment of rent from the client, the financial institution has to take into consideration the reason for the non-payment. If the client has a valid excuse for non-payment, the financial institution has to show leniency so that the client does not feel over-burdened, and the client should give more time to make the payment. In theory, if the financial institution charges any extra amount as compensation for the late payment, the amount would be considered as interest and therefore is not permitted in Islam. If there is no genuine reason for the late payment, the financial institution can ask the client to make a payment to a charity as penalty (Usmani, M.T. 1998, p.172). This prohibition of charging late fees makes it even more important for Islamic financial institutions to carefully evaluate each application before entering into an agreement.


Criticism of Musharaka



Musharaka is sometimes criticized as being an old instrument that cannot be applied in the modern world. However, this criticism is unjustified. Islam has not prescribed a specific form or procedure for Musharaka. Rather it has set some broad principles which can accommodate numerous forms and procedures (Usmani, M.T. 1998, p.29). A new form or procedure in Musharaka that would make it suitable for modern financial needs cannot be rejected merely because it has no precedent in the past. In fact, every new form can be acceptable as long as it conforms to the principles laid down by Shari’ah. Therefore, it is not necessary that Musharaka be implemented only in its traditional form (Usmani, M.T. 1998, p.30).

Another criticism leveled against Musharaka is based upon the issue of profits being guaranteed by some financial institutions. Even though Musharaka is considered to be the most authentic form of Islamic financing, the risk associated with sharing losses means that it is not as popular as the other modes. To make the product more appealing to the customer, some financial institutions have started guaranteeing profits in Musharaka. By doing so, these institutions are contravening the basic law of Islamic finance that requires linking rewards to risks (Warde 2000, p.5). If profits are guaranteed, the risk factor is eliminated, making the profit resemble interest. Although these actions may help Islamic banks grow in the short-run, the long-term costs (harm to reputation and authenticity) will outweigh the benefits. Such moves also provide ammunition to the critics of the system, who are already questioning whether the system is nothing more than an interest-based system operating under the guise of profit (The Economist 1994).




Although not as popular as other Islamic financial instruments, Musharaka is still considered to be one of the most authentic forms of Shari’ah approved financing. Recognising the problem that some financing instruments used by Islamic financial institution closely resemble interest-bearing instruments, Muslim scholars have voiced their opinion that more profit-and-loss sharing instruments should be developed and used. In recent times there have also been calls for Muslim countries to follow the lead of Iran and Pakistan, where their governments have enforced the Islamic financial system as the only available finance option. The push for such actions to be taken means that Musharaka’s use as an Islamic financial instrument will continue to rise in the future. Also, by relying on Musharaka for financing projects, Islamic financial institutions can erode any fears that Islamic financial institutions are essentially providing interest-bearing products under the guise of profit and mark-up has hurt their reputation. This is important for the survival and future growth of Islamic finance.




Ariff, M. (1988). Islamic Banking. Asian-Pacific Economic Literature, Vol. 2, No. 2, pp.46-62.

De Jonge, A. (1996). Islamic Law And The Finance Of International Trade. Melbourne: Monash University Working Paper.

Dudley, N. (2001). ‘Islamic Banks Tap A Rich New Business’ Euromoney, December

Gafoor, A.L.M. (1996). Interest-Free Commercial Banking. Malaysia: A.S.Noordeen.

Jaffe, C.A. (2002). ‘Financial Forms Tailor Products To Lure Muslims’ Boston Globe, 20 January

Lewis, M.K. & Algaoud, L.M. (2001). Islamic Banking. Cheltenham, UK: Edward Elgar.

Malaysian Business. (2001). A Welcome Alternative. Dec 16

Rahman, Y.A. (1994). Lariba Bank. Islamic Banking: Foundations For A United & Prosperous Community. Hiawatha, IA, USA: Cedar Graphics.

Saeed, A. (1996). Islamic Banking And Interest: A Study Of The Prohibition Of Riba And Its Contemporary Interpretation. Leiden, The Netherlands: E.J.Brill.

Saeed, A. (2001), “Muslim Community Cooperative of Australia as an Islamic Financial Service Provider” in Abdullah Saeed and Shahram Akbarzadeh (eds.), Muslim Communities in Australia. Sydney: UNSW Press, pp.188-205.

Siddiqui, M.N. (1987). Partnership And Profit-Sharing In Islamic Law. Leicester, UK: The Islamic Foundation.

Siddiqui, M.N. (1994). Issues In Islamic Banking: Selected Papers. Leicester, UK: The Islamic Foundation.

The Economist. (1994). Islam And The West: A Survey – The Cash-Flow Of God. August 6th pp.9-10.

The Economist. (2001). Forced Devotion Series: Finance And Economics. February 17 pp.76-77

Usmani, M.I. (2002). Meezanbank’s Guide To Islamic Banking. Karachi, Pakistan: Darul-Ishaat.

Usmani, M.T. (1998). An Introduction To Islamic Finance. Karachi, Pakistan: Idaratul Ma’arif.

Warde, I. (2000). Islamic Finance In The Global Economy. Edinburgh: Edinburgh University Press.