Essential Guide to Islamic Finance for Singaporean Muslims
Zul Hakim Jumat, Deputy Managing Director, Islamic Finance Singapore
Ezzat Ezzuddin Abdul Jalil, Associate, Islamic Finance Singapore
What is Islamic finance?
Islamic finance is no longer a newly introduced sector in the long-established world of conventional finance. Although Islamic finance is a relatively small player in the global financial industry, its rapid growth and development over the past few decades have significantly impacted the lives of Muslims by offering more equitable alternative financial solutions.
In contrast to its conventional counterparts, Islamic finance goes beyond the economic and financial aspects of transactions. It places equal emphasis on the ethical, moral, social, and religious dimensions to enhance equality, justice, and fairness for the good of society as a whole.
Islamic finance manifests its value proposition by having Shariah (Islamic law) as the bedrock of its systems and operations. It is founded on distinct characteristics and principles emphasised by Shariah, the primary sources of which are the Holy Quran and the Sunnah of Prophet Muhammad (ﷺ).
What is the difference between Islamic finance and conventional finance?
Islamic finance functions similarly to conventional finance in that both acts as economic intermediaries, channelling funds from surplus units to deficit units and vice versa. However, Islamic finance differs because its operations are done in a Shariah-compliant manner. Some of the salient features of the Islamic financial system that make it distinct and unique from its conventional counterparts include the following:
Every established aspect and matter in the operationalization of Islamic finance is based on the rules and principles of the Islamic faith and law. Unlike conventional finance, which offers ultimate freedom, the principles of halal (lawful) and haram (unlawful) in Shariah have provided a moral filter for actions and form a legal framework for Islamic finance. In addition to the rules and regulations that are already in place by the respective country’s governing authority, Islamic finance has an added layer of governance based on its own Shariah framework and governance, which makes it more thorough and comprehensive.
2. Money is not a commodity
Islam does not regard money as a commodity. In Islam, money is limited to acting as a medium of exchange, store of value, and unit of measurement for facilitating daily transactions and business activities. As money is not a commodity, Muslims cannot profit from trading it with themselves. Therefore, it cannot be sold at a price higher than its nominal value or rented out. Whereas in conventional finance, money is treated as a commodity and traded via interest-based loans, which ultimately may lead to inflation. Islamic finance promotes the stability of the currency. This is particularly true when the money flows through Islamic financial modes that are tied directly to the flow of goods and services. Hence, there is limited space for a sudden and mass movement of funds compared to the flow of interest-based short-term funds.
3. Prohibition of riba’ (interest), gharar (excessive ambiguity), and maysir (gambling/zero sum game)
The most distinctive feature of fiqh muamalat in Islamic finance is the law of prohibitions on three elements, namely, prohibition of riba’ (interest), prohibition of gharar (excessive ambiguity), and prohibition of maysir (gambling/zero sum game). The prohibition on these three elements has been clearly stated in the Quran and Sunnah. Conventional finance has no such prohibitions, as its financial system works freely with no moral-based legal boundaries. These prohibitions are evidence of the beauty of Islamic finance, as Shariah considers society’s well-being above the material aspect. A detailed explanation for each prohibition will be discussed further in “basic principles of Islamic finance” section.
4. Various contractual relationships
Another distinguishing feature of Islamic finance is the variety of contractual relationships available. Unlike conventional finance, where the relationship is limited to creditors and debtors, the relationship between the contracting parties in Islamic finance differs and varies depending on the nature of the established Shariah contracts. There are four (4) main categories of Shariah contracts, namely: exchange-based contracts, charity-based contracts, waiver contracts, and partnership contracts. Each category is different from one to another, mainly with regard to its purpose and legal effects, such as transfer of ownership, risk-taking, and profit distribution. The basic conditions and requirements of the contracts are also different from one to the other due to differences in the nature of the contracts. Hence, these classifications are significant in determining the rules and conditions that need to be met completely to make the contracts valid and enforceable, and in turn, all the legal effects of the contract will take effect.
The table below summarizes the differences between Islamic finance and conventional finance:
| Aspect | Islamic Finance | Conventional Finance |
| Rules and Regulations | Shariah (Islamic law), supplemented with the regulatory requirements | Limited to the regulatory requirements |
| Money as Commodity | No | Yes |
| Prohibition of Interest (Riba) | Yes | No |
| Prohibition of Gharar (Excessive Ambiguity) | Yes | No |
| Prohibition of Maysir (Gambling/Zero Sum Game) | Yes | No |
| Contractual Relationship | Yes, and various | No, limited to lender and borrower |
Why Islamic Finance?
People argue that Islamic finance is the same as conventional finance, claiming it is another brand in the conventional finance field. Moreover, the public argues that Islamic finance is charging interest and exploiting its customers. They believe that Islamic finance merely uses Arabic terms to manipulate customers into believing that financing is not the same as a loan when it is and has always been the same. Are all these claims true? How far are the claims false?
Before answering the question, let us take an example of halal and non-halal foods. For example, what differences do fried chicken from a halal and non-halal restaurant in terms ok look and taste? Both looks fried and tastes juicy. But, as a Muslim, it is unlawful for us to consume non-halal products. Despite the fact that both fried chicken looks the same in halal and non-halal restaurants, the process of preparing the fried chicken is completely different, especially in the slaughtering manner and preparation process. Islam has stipulated a specific guideline in slaughtering activities, i.e., to mention Allah’s name while slaughtering the animal. Thus, the different process of preparing the food will dictate whether such food is lawful or unlawful for Muslims.
The Quran, in surah al-Baqarah, verse 275, alluded to same fallacious claim: “Those who take riba (usury or interest) will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they have said: “Sale is but like riba.’’, while Allah has permitted sale, and prohibited riba. So, whoever receives an advice from his Lord and desists (from indulging in riba), then what has passed is allowed for him, and his matter is up to Allah. As for the ones who revert back, those are the people of Fire. There they will remain forever.”
Therefore, following the examples above, do you still view Islamic finance is the same as its conventional counterpart and that are no differences between them? From what you can see, both Islamic finance and conventional finance indeed have effects on the economy and society. Both are geared towards increasing economic growth while achieving social development. Both are also using and offering almost similar financial instruments and solutions. However, are the underlying operations and systems for Islamic finance the same as or similar to conventional finance? Is the profiting mechanism and process in Islamic finance different from conventional finance? As per the detailed explanation from the previous section, you can see the distinctive features and unique characteristics of Islamic finance as opposed to conventional finance. Islamic finance has its own unique set of value propositions. It stands by its principles and rules and will never be the same as conventional finance.
Basic principles of Islamic Finance
In essence, the three main principles of Islamic finance are: abstaining from interest, avoiding excessive ambiguity, and shunning gambling (zero-sum game) instruments. This section will detail the basic principles of Islamic finance.
1. Abstaining from riba (interest-based) practices
Riba or interest means “an excess, growth, or increase” and is interpreted as “any unjustifiable increase of capital, whether in loans or sales, with the passage of time.” Any positive, fixed, predetermined rate tied to the maturity and the principal amount is considered riba and unlawful. The prohibition of riba is the central tenet of Islamic finance (surah al-Baqarah, verse 275–280). Charging interest, as practised by the conventional financial system, is unjust to both the lender and the borrower, as they have to repay their debts irrespective of their financial situation and the outcome of their business venture.
2. Avoiding gharar (excessive ambiguity) in financial dealings
Gharar means risk, hazard, uncertainty, or ambiguity. In Shariah, “gharar” refers to any transaction involving probable matters whose existence or characteristics are uncertain due to a lack of information, either party’s ignorance of essential elements in the transaction, or uncertainty about one party’s ability to honour the contract. The main reason for the prohibition of gharar is to avoid future disputes. If the parties involved are not fully aware and clear about any material information about the contracts, they might be engaged in unexpected financial responsibility and commitment. This could lead to disputes among the parties arising from an unjustified term in the financial dealings due to misrepresentation and fraud. Islam requires all aspects of the transaction or contract to be transparent and known to all involved parties, thus significantly reducing any potential conflict, as mentioned in a hadith in which Abu Hurairah (RA) said that “the Messenger of Allah (ﷺ) forbade gharar (ambiguous) transactions and hasah transactions (sale of an item selected through the throwing of a stone).” (Sahih Muslim, hadith no. 1513).
3. Shunning maysir (gambling) instruments and behavior
Maysir means gambling. Islam prohibits all types of gambling as they pose extreme risks. Any form of business activity where the acquisition of wealth or money is derived and achieved from pure speculation or a mere chance, without any substantial effort, is categorized as gambling, and it is prohibited. Gambling is seen as a zero-sum game, as it ends up enriching one party at the expense of the other. It is strictly prohibited in Islam as it invokes enmity in society and distracts believers from worshipping Allah SWT, as mentioned in Surah al-Ma’idah, verse 90: “O believers! Intoxicants, gambling, idols, and drawing lots for decisions are all evil of Satan’s handiwork. So shun them so you may be successful.”
4. Steering clear of investment in unlawful business dealings and industries
Another important principle to highlight is the total avoidance of investment in unlawful business dealings and industries as mutual corporation towards lawful activities is one of the salient virtues of Islamic finance. Investment in Islamic finance is grounded in specific Shariah rules and guidelines to which Muslims are bound to adhere. Muslims are prohibited from investing in companies whose core business activities clearly violate Shariah principles, such as intoxicants, gambling, and non-halal food businesses. Investing in any unlawful business means that one is collaborating with and blessing such haram activities, which Muslims are not permitted to do, as stated in Surah al-Ma’idah, verse 2: “… cooperate with one another in goodness and righteousness, and do not cooperate in sin and transgression. And be mindful of Allah. Surely Allah is severe in punishment.”
Higher Objectives of Islamic Finance
The inception of Islamic finance is not for the mere sake of existence. The establishment of Islamic finance is a manifestation of fiqh mumalat, which falls under one of the three main areas of Shariah. Islamic finance plays a vital role in governing, supervising, and facilitating humankind’s daily transactions and business activities. As Shariah is the underlying structure, the whole Islamic finance ecosystem’s highest objective is to realise the people’s wellbeing and protect them against any harm or corruption. This can be briefly explained as follows:
1. Preservation of wealth
In Islam, Allah is the original owner of wealth, and humankind is entrusted with managing wealth in a right and prudent manner. The positions of humans are mere agents in managing wealth. Hence, humans are responsible to Allah for how the wealth is managed, as it will be asked later in the Hereafter. This is where Islamic finance comes in to realise this objective. Islamic finance serves as a helpful medium for people to manage and preserve their wealth in accordance with Shariah principles and guidelines. It aids and assists Muslims in reaping the benefits of wealth while protecting their interests from harm.
A clear example can be seen in Takaful, the Islamic version of conventional insurance, where it acts as a tool in mitigating the risk of loss of wealth by providing financial security or a financial blanket in times of difficulty and need. A part of the Takaful’s contribution consists of cash value, which one can enjoy upon maturity. This demonstrates that wealth preservation through Takaful is one of the highest objectives in Islamic finance, as it helps to safeguard one’s wealth against financial risks or any damaging threats to physical assets while complying with Shariah principles and guidelines.
2. Harmonizing the material needs and spiritual pursuits
Even though, under the principle of Islam, wealth belongs to Allah, Islam recognises private ownership of wealth. Individuals who gain wealth according to the principles of Islam have a right to it. Similar to profit or income, Islam recognises it as long as it is done or achieved in accordance with the Shariah principles and guidelines. Thus, Islam has strict rulings on wealth exploitation and the illegal possession of wealth that belongs to others, as both of these illegal acts are considered a breach of the private right of individuals to own and benefit from the wealth. Islamic banking is the set of examples for this case. As we all know, Islamic banks are profit-based financial institutions, and they always need to strategize on how to ensure their business keeps growing and has a continuous income stream for a long time. However, Islamic banks also need to ensure that their businesses are being conducted without involving any prohibited elements and following all Shariah requirements and guidelines. In contrast to conventional finance, which allows them to run their businesses with interest-based activities and capitalistic methodology, Islamic banks are not permitted to do so.
The whole operation of Islamic banks must be within the Shariah framework, such that the markup profit in financing shall be based on the buy and sell of the underlying commodities, and neither profit nor capital shall be guaranteed in an equity financing contract. The integration or assimilation of Shariah principles into the business activities of Islamic banks shows the harmonisation between material needs and spiritual pursuits. The material needs of Islamic banks are driven by the profit element, whereas spiritual pursuits are driven by Shariah compliance. As a result, the operation of the Islamic banking sector is substantial evidence of Islamic finance’s highest goal of balancing material needs with spiritual pursuits.
3. Balancing individual needs and social responsibility
Apart from material needs and spiritual pursuits, the highest objective of Islamic finance can also be seen when there is a check and balance between individual needs and social responsibility. Islamic finance carries the responsibility to narrow the gaps between the rich and the poor by ensuring proper wealth circulation in society. Zakat, Waqf, and Sadaqah are a true set of examples in this case. Islamic social finance instruments have played an integral role as an enabler of social development for the Muslim community.
Zakat, for example, is an act of cleansing one’s wealth by taking a portion of it to give to the poor and other beneficiaries. It has played an important role in redistributing wealth and purging people of greed and selfishness. It is an act to acknowledge that everything we own belongs to Allah, and it is for Him that we strive to end poverty and help our Muslim brothers and sisters. Similar to Waqf, the act of giving something in perpetuity has become the major source of income for social and economic development in an Islamic state. Thus, this proves that Islamic finance intended financial inclusion objective, which balances individual needs with social responsibility.
Conclusion
In conclusion, Islamic finance does not equate to conventional finance, as Islamic finance has its own value propositions and works in its own way. Moreover, Islamic finance is a blessing from Islam that Muslims should treasure. It enables Muslims to conduct their business dealings needs in compliance with Shariah principles without excluding the commercial or material aspects.
For the Singapore context, Islamic finance is still in the works and requires public support to flourish. Therefore, it is our mutual responsibility to spread awareness and increase the understanding of Islamic finance, especially among Singaporean Muslims. May Allah grant us rewards for our efforts.
For more information on Islamic finance, please visit: www.islamicfinancesg.com
