OVERVIEW OF ISLAMIC FINANCE • OFFICE OF INTERNATIONAL AFFAIRS OCCASIONAL PAPER NO. 4 • JUNE 2006
while ensuring their compliance with all applica-ble and relevant legal and regulatory constraints.
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Due to the industry’s small size, a limited numbero key players in each o those three categorieshave emerged as clear leaders.
hIStoRICAL RootS oFISLAMIC FInAnCE
In the late 19th Century, the Ottomans intro-duced western-style banking to the Islamic worldto nance their expenditures. While some Islamic jurists approved o modern banking practices, themajority ound those practices to be violations o Islamic prohibitions against usury (Arabic term:
riba
, equivalent to the Hebrew
ribit
, and inter-preted in its classical Biblical sense o any interestcharge on loans, as opposed to the modern iden-tication o usury with exorbitant interest). Thisresentment continued through the Europeancolonial period, which lasted into the mid-20thCentury. Islamic revival played a central role inthe intellectual and social oundations o inde-pendence movements o the mid-20th Century.To many intellectual ounders o the movement,political independence was to be supplemented with economic independence, through the de-nition o an Islamic economic system.Early writings on what came to be known as “Is-lamic Economics”ocused on macroeconomicdevelopmental issues. By the 1970s, theoreticaldiscussions o Islamic economics had given riseto practical discussions o Islamic nance, whichturned juristic in nature: how can Muslims replace(conventional) nancial practices (deemed to beusury/
riba
-based) with Islamic alternatives. Mid-Century literature suggested a prot-and-losssharing silent partnership alternative to interest-based lending. The Arabic name o this contractis
mudaraba
, which is akin to the medieval Eu-ropean
Commenda
contract, and the Jewish
Heter Isqa
, designed similarly to avoid usurious lending in Jewish and early Catholic Law.
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This partnership-based ocus survives in someIslamic nancial practices (e.g., as a substituteor interest-bearing bank deposits). However, with the help o Islamic jurists and lawyers, asdiscussed in the introduction, Islamic nancialpractitioners were soon able to provide close an-alogues to almost all nancial products, includ-ing various debt-instruments and xed-incomeinvestment vehicles. We shall summarize some o the most widely used Islamic nancial modes o operation in the ollowing section.
MoDES oF opERAtIon InISLAMIC FInAnCE
There are many contract and institutional ormsused within the industry collectively known as Is-lamic nance. Specics vary across countries andsectors. In this overview, we shall concentrate onsome o the basic and central modes o nanc-ing that are most popular in Islamic nance to-day. When signicant dierences exist betweenimplementations o a particular Islamic nancialtransaction in dierent regions or sectors, we notethose dierences briefy.
Csmer ad Bsiess LaAleraives
The juristic-based understanding o orbidden
riba
/usury suggested that Islamic nance has tobe “asset-based”, in the sense that one cannotcollect or pay interest on rented money, as onedoes in conventional banking. Thereore, the eas-iest transactions to Islamize were secured lending operations, e.g., to nance the purchase o realestate, vehicles, business equipment, etc. Threemain tools are utilized or this type o retail -nancing:
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In this regard, Islamic nance has to adhere to multiple legal requirements; or clarity, this paper will reer to religiousconstraints as “juristic”, and reserve the terms “legal”and “regulatory”or sovereign-imposed constraints.
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On
Mudaraba/Commenda
, see Udovitch, Abraham L.
Partnership and Proft in Medieval Islam
. Princeton, N.J: PrincetonUniversity Press, 1970. On the Isqa (alternatively spelled Iska) contract, see Stern, J. “Ribit: A Halachic Anthology”,
Journalo Halacha and Contemporary Society,
46, 1982. Sample Iska orms are available at:http://www.jlaw.com/Forms/iska_d.html.
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