{"id":20698,"date":"2014-02-25T08:48:41","date_gmt":"2014-02-25T08:48:41","guid":{"rendered":"http:\/\/www.ikim.gov.my\/new-wp\/?p=20698"},"modified":"2014-02-25T08:48:41","modified_gmt":"2014-02-25T08:48:41","slug":"the-notion-of-no-risk-no-gain-in-islamic-finance","status":"publish","type":"post","link":"https:\/\/www.ikim.gov.my\/en\/the-notion-of-no-risk-no-gain-in-islamic-finance\/","title":{"rendered":"The Notion of No Risk No Gain In Islamic Finance"},"content":{"rendered":"

In one of his sayings, the Prophet asserted that the entitlement to the return on an asset relates to the risks of ownership i.e. \u201c<\/span>al-kharaj bi al-dhaman<\/em>.\u201d Based on this hadith, Muslim jurists developed a legal maxim \u201ca<\/span>l-ghurm bi al-ghunm<\/em>\u201d or gain is justified with risk. Both imply that the entitlement to a return is related to the liability of risk. Simply put, in Islam, if there is no risk, there shall be no gain. The hadith also provides a clear stance in Islam regarding its recognition of risk for justification of earnings in any economic venture. Indirectly, it also entails that in the absence of the risk element in business undertakings, one may find oneself in a circumstance that might give rise to interest-based transactions which is strictly condemned and prohibited in Islam (Quran 2:275-279).<\/span><\/p>\n

Nowadays, the notion of no risk no gain is widely applied by Islamic finance and banking institutions through the concept of\u00a0mudarabah<\/em>\u00a0and\u00a0musyarakah<\/em>.\u00a0Mudarabah<\/em>\u00a0is based on profit sharing principle. In\u00a0mudarabah<\/em>\u00a0partnership, the\u00a0rab al-mal\u00a0<\/em>(owner of capital) and the\u00a0mudarib<\/em>\u00a0(enterpreneur) share the profits on a pre-determined ratio mutually agreed by both parties. However, in the event of loss under normal circumstances, it would be borne solely by the capital provider while the\u00a0mudarib<\/em>\u00a0would suffer reputational loss among business community which is non-pecuniary in nature but has a devastating impact on his image.<\/p>\n

On the other hand, the\u00a0musyarakah<\/em>\u00a0concept is based on profit loss sharing principle. Profit in\u00a0musyarakah<\/em>\u00a0partnership is shared according to contractual agreement but the liability of loss is proportionate to the capital contribution.<\/p>\n

Besides sharing based principles, there are two more major kinds of business approaches approved by the\u00a0Syariah<\/em>\u00a0i.e. sale-based and leased-based. In both categories, finance institutions are also expected to assume certain risks such as ownership risk in order to justify the returns earned from the contract.<\/p>\n

In sale-based contracts such as\u00a0 deferred payment sales (bay\u2019 al-ajil<\/em>), forward sale with cash advance (salam<\/em>) and manufacturing financing sale (istisna<\/em>\u2019), profits are earned through the mark-up mechanism or\u00a0murabahah<\/em>. According to Kahf (2006),\u00a0murabahah<\/em>\u00a0is the most popular mode of financing in Islamic banks today whereby it occupies up to 90% of the total financing in certain banks. One of the reasons that contribute to this scenario is that the concept of mark-up offers a wide opporturnity to the financial institutions to create exorbitant incomes.<\/p>\n

In addition to sharing and sale-based principles, Islam also allows the concept of\u00a0 leasing or\u00a0al-ijarah<\/em>\u00a0as a form of financial contracting. The Securities Commission Malaysia defines\u00a0al-ijarah<\/em>\u00a0as\u00a0\u201ca manfaah<\/em>\u00a0(usufruct) type of contract whereby a lessor (owner) leases out an asset or equipment to his client at an agreed rental fee and predetermined lease period based upon the `aqd<\/em>\u00a0(contract). The ownership of the leased equipment remains in the hands of a lessor\u201d. This contract is normally used by financial institutions for vehicle financing and sukuk instrument.<\/p>\n

When analysed, each category of the abovementioned contracts has its own distinguished criteria that suit well to the clients\u2019 needs whose preference vary from one individual to another. Nevertheless, as a fast growing sector, industry players sometimes overlook the Islamic worldview of economics that centres around the concept of\u00a0amanah<\/em>\u00a0which ultimately ends with\u00a0al-falah.<\/em>\u00a0Among others, the worldview of Islam states that social gain has preference over private benefit, cooperation over competition. However, to deny the banks from making profits is untenable. Nonetheless, they must strike a balance between profit maximisation and social gain.<\/p>\n

According to Hasan (1985), in a system where interest and profit loss sharing financing co-exist, the aggregate profit sharing ratio is a function of the overall rate of returns on investment, rate of interest, degree of leverage and risk premium. However, when the banks accustomed to this cheap money policy i.e. pay depositors low rate of returns and charge high price on the financing side, it might create a problem of distributive justice in the sense that the returns to bank shareholders\u2019 capital magnifies tremendously.<\/p>\n

Sale of commodity on the basis of\u00a0murabahah<\/em>\u00a0is allowed in Islam. In fact, it is a pre-Islamic practice and can be either with immediate, instalment or deferred payment; spot or future delivery.<\/p>\n

However, when the sale structure is compromised, we can question the\u00a0halal<\/em>ness of such a sale contract. For instance, in commodity\u00a0murabahah<\/em>\u00a0(CM), there are elements of\u00a0bai\u2019 al-Inah<\/em>\u00a0(sell and buy back) and tawarruq munazzam<\/em>\u00a0(pre-arranged\u00a0tawarruq<\/em>\u2014in which the financial institution buys an asset or commodity and sells it to the client on deferred payment basis; then the client appoint the financial institution as his agent to sell the commodity to the third party for cash at a price which is normally lower than the deferred price that defies the concept of realism in Islamic economics and finance. In CM, the contracting parties do not intend to own the commodity (either CPO or metal) and as a matter of fact, no delivery takes place. The pre-arranged nature in the contract is only a means to allow interest taking and it does not stick to the concept of realism expounded\u00a0 by the\u00a0Syariah<\/em>\u00a0(Kahf, undated).<\/p>\n

This is similar to the\u00a0ijara<\/em>h contract. Eventhough the Quranic text and prophetic traditions validate the legality of the practice of\u00a0ijarah<\/em>, often we notice that banks violate certain\u00a0Syariah<\/em>\u00a0stipulations attached to the concept. For a valid ijarah contract, the bank as the lessor must bear the risk related to the ownership of the leased asset. In fact, whether it is a sale contract or lease contract, the rule of al-kharaj bi al-daman<\/em>\u00a0and\u00a0al-ghurm bi al-ghunm<\/em>\u00a0apply to both situations.<\/p>\n

In reality, the contract of\u00a0al-ijarah<\/em>\u00a0in Islamic banks adopts the same risk structure of the conventional leasing facility offered by its conventional counterpart. As such, it is nothing uncommon for the lessee to keep paying the rental or\u00a0 servicing the instalment payments to the bank albeit he is denied the use of leased asset as it is no longer in existence due to force majeure damage. The bank takes no responsibility to offer any replacement asset or inform the client to discontinue the rental payment.<\/p>\n

In its original objectives, each contract that is approved by\u00a0Syariah<\/em>\u00a0suits the diverse needs of people. Defective structuring and indiscreet use of these contracts as explained by Hassan (2008) have made Islamic finance becoming more exploitative and akin to the conventional system. In view of this, Islamic finance should operate within the Islamic worldview and any divergence from\u00a0Syariah<\/em>\u00a0guidance would definitely jeopardise the future of the industry as people will be skeptical towards its original roles i.e. to create a banking system which is\u00a0 free from all sorts of exploitation.<\/p>\n","protected":false},"excerpt":{"rendered":"

In one of his sayings, the Prophet asserted that the entitlement to the return on an asset relates to the risks of ownership i.e. \u201cal-kharaj bi al-dhaman.\u201d Based on this hadith, Muslim jurists developed a legal maxim \u201cal-ghurm bi al-ghunm\u201d or gain is justified with risk. Both imply that the entitlement to a return is…<\/p>\n","protected":false},"author":18,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_analytify_skip_tracking":false,"_wpzoom_pinterest_image_url":"","_wpzoom_pinterest_hidden_image":"0","_wpzoom_pinterest_description":"","footnotes":""},"categories":[220],"tags":[],"class_list":["post-20698","post","type-post","status-publish","format-standard","hentry","category-the-star","category-220","description-off"],"_links":{"self":[{"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/posts\/20698","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/users\/18"}],"replies":[{"embeddable":true,"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/comments?post=20698"}],"version-history":[{"count":0,"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/posts\/20698\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/media?parent=20698"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/categories?post=20698"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.ikim.gov.my\/en\/wp-json\/wp\/v2\/tags?post=20698"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}