Islamic Finance

Islamic Finance

by MSC

In 2017, we pioneered the implementation of Islamic Microfinance in Uganda, an avenue that expanded micro-funding choices for our existing and new clientele. However, being a newly introduced mode of financing in Uganda, there are misconceptions and a general lack of understanding of what Islamic Finance is all about.

What is Islamic Finance?

Islamic Finance (also referred to as interest free finance, ethical finance or participative finance) is a financial system that is guided by the principles of Islamic (Shari’ah) law. While it dates back to the beginning of Islam, it was not until 1963 that the first Islamic bank was established (in Egypt).

Islamic law prohibits the charging of interest (riba) as it is considered a form of injustice. According to the Law, money does not have intrinsic value and as such cannot be treated as a commodity. Therefore, Islamic financial institutions enter into partnership with their clients to invest in tangible projects or assets that are grounded in a real, as opposed to a speculative, economy.

Further, projects deemed unethical or socially irresponsible according to the Law, such as piggery, alcohol distilling, gambling or adult entertainment, cannot be invested in.

Is it only for Muslims?

Contrary to the myth, Islamic Finance is NOT only for Muslims. Sharia’h law is composed of five components, four of which require one to be Muslim or convert to Islam. However, the component referred to as man-to-man activities (muamalat) has no restrictions on religious affiliation. This component places emphasis on how humans relate with each other as far as political, social and economic activities are concerned. Islamic Finance falls under this component.

What modes of Islamic Finance does MSC offer?

1. Musharaka (Equity financing/partnership) means a joint enterprise or venture between two or more partners, in which the partners contribute capital (Musharaka capital) and share the profits and losses generated by the venture in accordance with the percentage contribution to the Musharakah contract.

2. Murabaha (Cost plus financing) is a transaction of sale of goods at their capital cost plus an agreed profit mark up. In this mode of financing, the seller declares the cost at which the good was purchased, and stipulates the amount of profit in addition to this. The purchase price and the profit should be known to the purchaser.

3. Mudaraba (trustee financing contract) is a form of partnership in which the financier or the investment capital owner (Rab-Almal) entrusts investment capital to the entrepreneur (mudarib) for undertaking an activity; while the entrepreneur provides expertise and effort to run the business. may not engage in the management process, but will periodically monitor the progress of the project that has been financed.

4. Salam (forward sale) refers to a contract in which advanced payment is made for goods to be delivered at an agreed future date. It may be used as an indirect financing of the purchase of raw materials.

5. Istisna is a contract based transaction under which a manufacturer agrees to complete a construction project on a future date for a fixed, agreed-upon price and with product specifications that both parties agree to. If the project doesn’t fit the contract specifications, the buyer has the right to withdraw from it. The contract doesn’t demand that the buyer pay in advance or that the manufacturer receive only a lump sum at the time of delivery. Instead, both parties can set a schedule of payment. This mode is widely used in the construction industry or for project/trade financing.

6. Ijara is similar to a conventional lease. The owner rents or leases his property or goods to a lessee for a specified time period at a fee. However, it is different from a conventional lease in that the lessor must own the assets for the full lease period; the lessor cannot charge interest if the lessee defaults on payments or delays payments; the leased asset’s use is specified in the contract.

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