Understanding Various Aspects of Islamic Trading

on Saturday, June 29, 2013

Banking in Islam provides savings and deposits in investment accounts that are based on mudaraba scheme. In this scheme, depositors to the accounts share profits/losses incurred by the institutions on the basis of an agreed-on formula. “Mudaraba Accounts” depositors are therefore capital suppliers, rabb al-mal, meaning the persons who entrust the financial institution with their funds, also known as speculator (Mudarib) in the Western investment banking style. The whole scheme is subjected to dealings involving only non-instruments which do not bear interests. Mudarib acts as a money-manager or agent, oversees the funds investment and later distributes profits/losses based on pre-defined contracts which meets various conditions including:

  • Profits are shared in proportions depending on the percentage of contribution from each party involved in Mudaraba account. Lump-sum guaranteed amounts are not permitted.
  • A depositor loss must not exceed the amount deposited.
  • Mudarib or manager, does not undertake in sharing of losses whether in save for his time and effort at managing the funds, and in instances where negligence is proven.

Many times, scholars have argued that this third provision opens doors for careless fund management through transactions which may subject the depositor to unprecedented losses. In Islamic countries where transparency is an issue, this aspect has proved extremely challenging leading depositors to suffer from huge losses. It is more applicable in nations where period disclosure of transactions and operations to stakeholders is encouraged and highly practiced.

There are two forms of Islamic trading derivatives which are implicit derivatives and explicit derivatives. Implicit derivatives from an economic point of view, “creditor-in-possession” based on lending system arrangements of Islamic trading replicates income conventional transactions in a manner accepted within Shariah law. On the other hand, when it comes to explicit derivatives, there is an extensive agreement that they are those derivatives which offer an option for unilateral deferment like delay in payment of contracts on assets involved or on the purchasing order with regard to future contracts.

Generally, it is noted that the structures of many Islamic trading are subject to lots of legal hindrances, thanks to weak reliance on financing of capital markets. Risk issuance is generally plagued with lots of uncertainty irrespective of whether it’s about the hedge funds of sukuk. It is noted that whilst “implicit derivatives” are vital in order to replicate interest via profit generation from assets transferred temporarily or even sharing of profits on Islamic finance, explicit ones are rather shrouded with lots of controversy.

Further, investors within the Islamic financing structures are concerned with many aspects let alone Shariah law compliance of derivative. It is therefore important that the Islamic derivatives satisfy two fundamental aspects, which are: applicability to commercial legislation and Shariah law alike. This is the precept which provides investors with security on their investment or not. Moreover, while the prospect of creation of Shariah compliant derivatives is acknowledged, it places the need to come up with unified interpretation mechanisms rather than relying on individual interpretations.

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