Over three decades ago, Islamic finance was considered a wishful thinking and to date over 400 Islamic financial institutions are managing funds across the globe. The Islamic finance clientele are not confined in Muslim countries alone rather they are spread over Europe, Far East and in United States of America. Through the use of Islamic teaching, Muslim have high opportunity to invest their finances due to the guaranteed safety that is evident.
Islam is a type of religion that is not limited in the sense of word but organize life completely in Mouaamlat used to define the financial dealing between people in the modern dictionary. Shariah is the Islamic law that is used to mean a clear path that ought to be observed and followed to the latter. Shariah is just law in abstract form and is capable of adaptation that allow a room for further development and interpretation. Sharia is further developed into other four major juristic schools consensus, individual reasoning and analogy, the transcription of Gods message to Prophet Mohammed and all the traditions of Prophet Mohammed. Muslims are working hard in balancing all their religious faith and believe with the modern technological world that have to work together for their own benefit in faith. Islamic teaching advocates for elimination of exploitation in all business transactions and establish justice that will benefit all those who are involved and they who are not. Dealings that contain excess risks and speculations are avoided at all cost and this is best done through various Islamic teachings, which are carried out in many places. Islamic finance is composed of two main principles that form the benchmark of its economics and they include Riba and Gharar. Riba is more concerned with the prohibition of interest rate that might be charged to the bank borrower. It represents the Islamic economic system that is prone to give birth to unjustified advantages. On the other side Gharar is used to mean uncertainty and speculation. Islamic economics increasingly has become a force to protect from financial crises and it is a strong alternative to conventional economics.
Mudarabah is also termed as Trust financing in Islamic economies, which is a form of partnership where one partner namely (Mudarib) manages investment through the use of his own expertise and the other partner (Rabul-amal) is responsible in the provision of the capital required for investment. The profits that result from the business are shared through the use of a pre-determine ratio that is always made fixed to all the partners. The capital provider is the one who bears the loss of the partnership in Mudaraba. Mudarib is the one in charge of managing all the investment that has been done in the business and will be questionable in case of any misconduct, negligence or violation of all the terms that were originally agreed upon. The key provider of funds to this type of investment is the Islamic bank that lend with interest.
Musahraka is a partnership financing even though it is mostly regarded as an old fashioned financing technique that only deal with small-scale investments that are taking place among the Muslim community. Profits in this case are only shared upon pre-agreed ration among the partners and losses shared on the ratio of investment. In this type of partnership all the partners contribute to the investment that is taking place even though it is not a compulsory. When a partner is partnering with the bank, he will be required to pay a certain amount of his own predetermined profit and share of profit to the bank that will mean the banks shareholdings power are drastically reduced. With time the customer will be the sole-proprietor of the business with no sharing of profits any more with the bank.
Islamic economics should be an alternative to the western system due to various reasons like the efficiency of the system that is highly used to ensure all the functioning are well run. Interest rate lending is highly avoided and is then replaced with rate of profit on profit sharing finance and equity. However, this is best attained through the use of rental rates on leasing finance and the credit purchase finance of the system to ensure efficiency is well attained. Complicated questions of how to reduce the interest rate are not handled and this is a soft way of ensuring that time-value of money is maintained. The ability of the borrower to repay principal and interest is a high consideration in the conventional finance. Therefore, the areas that are more profitable and best in giving good returns are the areas of high consideration in the modes of Islamic finance that is based on profit sharing and equity. Islamic finance is best in directing the financial resources that are used in the investment to the productive investments those will give good returns.
Islamic economies is an alternative of the western system due to the high stability that is experienced in the finance sector. Demand, time and saving deposits are liabilities that are guaranteed through the use of the conventional bank. Debt instruments are contained in its assets and are already depended on the borrower’s ability to correspond to the debt that has to be paid back to the bank in good time as agreed upon. There may be default that might result and they are mostly expected in times of crises that lead to inability to meet the banks obligations of paying the debt in good time. Liabilities of different nature must be experienced by a bank that is operating through the use of the Islamic nature. The risk are shared among the investment depositors who by all means have to incur the cost of facing the macroeconomic that has risen. And this is the reason as to why Islamic banking is termed as more stable banking system as compared to conventional banking of the west. The money present in the Islamic banking is mostly traded in the current integrated debt market to imply that a borrower is entitled to pay certain amount of money in the near specified future date. The automatic mechanism through which bonds through which short-term funds flow form one give area to another is made more effective and much easier through the use of the bond markets. The flows can best related to the economic fundamentals as they bring instability in national economies. The integrated market growth is very tremendous in size and the scale that is now recognized and incorporated well in the whole world economy. Economists are trying through all means to stop capital movement that was a hindrance to the stability of conventional bank. The selling of goods and services on credit is what brings debt in the Islamic finance. The nominal value for maturity is what the debt instruments are being traded for to ensure that there is no mass movement of funds. This is the reason why there is no instability in the banking system because, even institutional participants do not carry out huge speculative transactions as they may cause of instability to the system. Gambling activities are avoided at all cost to ensure that instability in the banking system is avoided at all cost. The mode of finance is more concerned with mode of money on one end to ensure stability is maintained. The markets operate more efficiently and smoothly because there is high considerations on demand changes.
Moral hazard and adverse selection is another advantage that qualifies the Islamic banking to be more prudent compared to the west banking system. The Islamic goods and services operate in universal rather than, commercial banks a factor that bring s advantage to the sector making more efficient for use. There are very many branches that can be operated by the universal banks. Finances are used of the rightful allocated purpose to prevent any mismanaging from occurring or even form taking pace in the Islamic banking sector and more so to improve the adverse selection of the system. When all the finance applicants are well screened, then adverse selection is avoided in good time and thus is the reason as why the bank is more urged to choose applicants who are likely to perform to avoid any adverse selection from taking place. Adverse selection is less probable with universal banking and on the other side screening is of more importance to enhance effectiveness. Universal banking is best to best for use because, it less exposed to moral hazard and adverse selection that act as a set back to the system. This is as a result of the help that come from the bank equity holder with the aim of protecting the investment. The use of equity and debt finances prevents any problem form occurring in the Islamic banking sector. In up and down turns, the universal bank is faced with less risks as compared to the commercial banks.
Finance and development have been highly experienced in the Islamic economies; thus making it more competent as compared to the west banking system. The financial activities are put right through the use of universal banking in all the Islamic banks globally in the midst of the developments that are taking place. An opportunity is offered by the Islamic bank that allows all to use much needed financial resource whereby, all Muslims can participate in the development process.
Integrity has been a key to the success of Islamic economies. Therefore the people in charge of lending the finances share the same risk with the people who have borrowed the money. Islamic bank savers are given choice of selecting the right investment after knowing how sacksful it will be to them and they share the risks of investment together with the bank. The proper corporate governance of the Islamic finance is the reason as to why depositors have influence to the bank investment decision through giving their contributions in regard to arising matters. The proper governance allows financial institutions and banks to make contributions to the decision making process done by the board of directors all the firms that receive funds with the aim of ensuring finances are well managed. Islamic economies are mostly preferred as they shares all the risks and involves wide range of people in the decision making process. When an Islamic financial institution is accorded all the right tools, they will contribute to the efforts that has been taken by the whole society.