Islamic Finance Key Principles Challenges And Performance Finance Essay - Free Essay Example

After redesigning my research objectives, I decided to change my research questions in order to make my subject more related to the corporate finance domain. The aim is to provide information for corporate finance managers dealing with a discipline that have a specific regulation, can be part of the current financial system and can bring to them new investment opportunities. The new research questions are: The main challenge with Islamic finance remains its position regarding to the conventional financial system. There are two main visions: The first one qualifies Islamic finance as an alternative system because of its size. On the other side, there is a vision that places Islamic finance as a viable financial system that could coexist with the conventional one. Johnson Douglas Clark (2008) said that Islamic finance is fast evolving from a niche within the global banking system to what may become in the next generation a track parallel to the conventional financial services. He argues his point of view by the development of Islamic wealth management services even if it doesnt exist at this time, because wealth coming from Islamic countries is integrated in to the conventional financial system. Aka Jahangir indicated in a report called World Islamic Finance report (2008) edited by Ernst Young that wealthy Islamic investors continue to choose conventional investment solutions over shariah compliant structures, justifying this opinion by supposing that the religious belief come after the inv estment performance. CIMB Principal (2010) evaluated the size and the importance of Islamic finance by the increase in the demand for the Islamic finance products. They mentioned that Muslims worldwide are estimated to 1.65 billion, which represents approximately 24% of the world population. They added that its an investment class that is open not only for Muslims but for non Muslims too. The openness of Islamic finance to all type of investors drives to an important challenge, which is the globalization of the Islamic finance. Johnson Douglas Clark (2008) said The faster the Islamic industry embraces globalization, the more apparent the commercial opportunity will become as Islamic bankers aim to compete the conventional names on price, pedigree and performance. This process will allow, in his point of view, Islamic finance to expand beyond its borders that are golf countries and south East Asia. Going global is a trigger for Islamic finance but it is difficult to build a global financial Islamic market. Johnson Douglas Clark (2008) pointed that investors have a tendency to invest in their local market because they have a good knowledge on opportunities. Moreover, divergences between scholars and shariah advisors in different countries can be a hurdle to globalization. CIMB Principal (2010) found that for example, in Malaysia, they have a full fledged Islamic capital market that have specific requirements such as shariah advisor appointed at a company level and a shariah compliance officer who checks if the transactions meet the shariah principles. For them, the shariah advisor must be familiar with the differences in shariah interpretation by jurisdiction. They admitted that these guidelines are different for other countries but they can be considered as a benchmark for the Islamic finance industry. Johnson Douglas Clark (2008) had a different opinion regarding this theory. He gave a good example of controversy dealing with an Islamic financial p roduct called WAD based SWAP. The divergence of the use of those products was between Sheikh Yusuf Tallal de Lorenzo of the United States and the industry leader Justice Taqi Usmani of Pakistan. Forte, G. and F. Miglietta (2007) confirmed Douglass point of view in their paper when they analyzed the Shariah boards. They compared the theory and the practical point of view. So, they mentioned the divergences to the different jurisprudential schools and the way they interpreted the religious texts. On the other hand they proposed the solution to this problem by delegating all the investment decisions to the Islamic indices that have already made a stock screening by eminent scholars. This lead us to ask several questions concerning global shariah standards but the main issue remains the global governance of this industry because it will bring more homogeneity and product innovation. At this time, there are no concrete findings and studies related to this specific issue. What are the key principles of the Islamic finance that makes it a dependent financial system? The key principles of the five Islamic finance pillars that regulate the Islamic finance services (Standard and Poors, 2008) are: The ban on interest The ban on uncertainty of speculation The ban on financing sectors like pork, gambling, weaponsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ The asset backing principle which predicts that each transaction must rely on a tangible asset The sharing principle of profit and loss between parties Those principles are underlying from two main primary sources. The first one is the holy Quran and the Sunnah  [1]  . In the ban of interest case, Allah said ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'ËÅ" £ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'ËÅ" ­ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‹Å" ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‹Å"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ÃƒÆ'â„ ¢Ãƒâ€šÃ‚  ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã¢â€ž ¢ÃƒÆ'ËÅ" ¨ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã¢â€ž ¢ÃƒÆ'ËÅ" ¹ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'ËÅ" ­ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'ËÅ" ±ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‹Å"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¦ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'ËÅ" ±ÃƒÆ'â„ ¢Ãƒâ€šÃ‚ ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‹Å"ÃÆ'ËÅ" ¨ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚ ½ÃƒÆ'ËÅ" Surat Albaqara, Ayat 275. That means Allah authorized selling and prohibited Riba  [2]  . The prophet Muhammad confirmed this statement in his Sunnah when he said that: ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'ËÅ" ¹ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚   ÃÆ'ËÅ" ±ÃƒÆ'ËÅ" ³ÃƒÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ ÃÆ'ËÅ" µÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ° ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒ Æ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ ÃÆ'ËÅ" ¹ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'ËÅ" ³ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¦ ÃÆ'ËÅ" ¢ÃƒÆ'â„ ¢Ãƒâ€ Ã¢â‚¬â„¢ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ ÃÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'ËÅ" ±ÃƒÆ'ËÅ" ¨ÃƒÆ'ËÅ" ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¦ÃƒÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒâ€ Ã¢â‚¬â„¢ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒâ€ Ã¢â‚¬â„¢ÃƒÆ'ËÅ"ÃÆ'ËÅ" ªÃƒÆ'ËÅ" ¨ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'ËÅ" ´ÃƒÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ÃƒÆ'ËÅ" ¯ÃƒÆ'â„ ¢Ãƒâ€¦Ã‚  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ÃƒÆ'ËÅ"Å’ ÃÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡ÃƒÆ'ËÅ"ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾ ÃÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¡ÃƒÆ'â„ ¢Ãƒ ¢Ã¢â€š ¬Ã‚ ¦ ÃÆ'ËÅ" ³ÃƒÆ'â„ ¢Ãƒâ€¹Ã¢â‚¬  ÃƒÆ'ËÅ"ÃÆ'ËÅ"à ƒâ€šÃ‚ ¡, reported by Imam Muslim. The meaning of this Hadith  [3]   is that the prophet damns the one who eats Riba (uses money issued from interest to satisfy his needs), the one who gives it to eat, the one who writes it as an act and the one who assist to this act and they are all the same. For this example, the statement is clear and the texts give a clear judgment. However, in other cases texts are not clear and need interpretation from qualified scholars. Therefore, a secondary source has seen the light. Its called jurisprudence and its main objective is to bring explanation and interpretation of complicated religious texts. At this level, findings are mainly written by classic scholars such as: Imam Al Bukhari and Imam Muslim in Arabic language. It was hard to find those books but I focused on some modern literature that discussed those principles. International organization of securities commission (IOSCO, 2004) has realized a report where they describe the sha riah principles. It was a basic presentation with no practical examples. They explain that there is a link between shariah rules that have an ethical foundation and socially responsible investment without highlighting which principle is related to ethics.In this report, IOSCO havent discussed several issues regarding the application of shariah rules in current financial market. Herbert Smiths report on Islamic finance guide la finance islamique (2009) detailed the shariah ruling and its practical application. This report made an analysis of shariah principles and prohibitions, raised a problematic dealing with shariah compliance between eastern and western sides, and highlighted practical techniques of Islamic financing with an analysis of the process from a general shariah point of view. On the other hand, the report included three real examples of innovative transactions. It adopted a comparative approach between the three transactions and examines issues on these modern applications with Shariah criteria. This report provides a new approach regarding modern issues of shariah principles but there is a need of further analysis to fulfill the gap that exists between religious and jurisdiction texts and the application of new and innovative Islamic financial product that make this industry competitive and viable. How Islamic investment funds perform in the global market compared to the conventional investment funds? Findings and researches dealing of the measure of performance of Islamic investment funds versus conventional funds are few. This can be explained by the lack of data and reliable information for this type of funds. Moreover, many Islamic investment funds have not a long tracking record because they were launched in the latest years. As a result, financial analysts havent a good overview of long term performance of these funds. However, there are some studies that were conducted with a small sample of funds. Edward Tower and James Dean (2010) have done small research for a conference dealing with Islam and economic development. They have chosen a sample of four Islamic mutual funds that are located in the United States in order to evaluate them against benchmarks. They have found some interesting results: Two of those funds over performed the benchmark even if they had higher expense ratios. The two other funds underperformed the benchmark; they justify this result only fo r one fund. They explain that this fund was launched less than six months so there is not a sufficient tracking record to explain its relationship to the index. Finally they concluded their paper by assuming that the turnover rate of Islamic funds which is low can be a key factor to their over performances of indexes, and this was clearly highlighted for the two first funds of the sample. In addition to this they focused on the fact that Islamic funds use a lot of screening and valuation of stocks that meet shariah principles is positive and can facilitate the portfolio construction. The results of this study cannot be a reference because of the sample size and the geographical concentration; Said Al Fakhani and M. Kabir Hassan have realized in 2005 a deeper study of Islamic mutual funds performance. First, they noticed that sources of data were very limited. Although, they managed to make their study with a reasonable sample of 46 funds with a minimum track record of tw o years for a period starting from 1st January 1997 to 31st August 2002. In their study, they chose funds with different geographical regions and different sectors that were classified into eight categories. The performance of those funds was assessed compared to two market benchmarks, an Islamic index and a conventional one. This methodology is very suited for this type of studies but the findings of this one were so general with no concrete statistical conclusion: S. Al Fakhani and M. Kabir Hassan said Our findings suggest that the behavior of Islamic mutual funds does not differ from that of other conventional funds, with some shariah-compliant mutual funds over-performing their benchmarks and others under-performing them. However, they gave a good remark concerning Islamic mutual funds which have a strong performance during the recession period explained by improving performance with time and managers gaining experience. Finally, there was a recent study conducted by Fadil lah Mansour and M. Ishaq Batti (2009) measuring the performance of Islamic mutual funds in Malaysia. This latter was chosen by them as its considered among leader countries in Islamic asset management industry. This study is relevant as the sample of fund studied is 535 funds. In their conclusion, they found the same qualitative result as M. Kabir Hassani and Said Al Fakhani (2005). They noticed that there is a strong correlation between Islamic mutual funds and conventional ones. Furthermore, they provide a statistical conclusion when they stated that higher growth rates were registered for Islamic mutual funds. They explained the statement by three factors which are stability expectations, higher growth rate and resilience during crisis.