Literature Review: Islamic Finance Structure and Products and Services in Afghanistan, Mauritania, Saudi Arabia, and Yemen
Islamic Finance Structure and Products and Services in Afghanistan, Mauritania, Saudi Arabia, and Yemen
Islamic finance refers to method through which corporate institutions including banks and other finance institutions raise capital while adhering to the Islamic or Sharia law. The term also defines the various forms of investments that are allowed by the Islamic law. Islamic finance forms a unique form of investment since the law that regulates the system does not make a distinction between religious and secular aspects of the society and hence its influence of the financial facet of the society. Islamic finance and banking are not relatively recent systems but have been practiced since the inception of Islam dating back to the seventh century. However, the formalization process dates back to the late 1960’s under the influence of the significant increase in oil wealth among the Arab nations that spurred an increasing interest in and need for financial products and services that complied with the Sharia law (Kuforiji, Abugri, & Andoh, 2014). Important to note as far as Islamic finance and banking is concerned is the significance of risk sharing and how it applies to raising capital and the avoidance of gharar (risk or uncertainty) and riba (usury).
Sharia law understands lending that is associated with interest payments as a relationship that tends to favor the lender who takes advantage and benefits from the borrower by charging interest. Islamic law further perceives money as a tool for measuring value as opposed to an asset. As a consequence, the law prohibits one from generating an income or value from money such as earning an interest. Gaining an income or an increase value, referred to as riba, from money alone is considered both exploitative and usurious. Syndicated financing is one of the forms of financing that has grown in use in the Islamic financial market in comparison to the conventional finance markets for a number of decades. Syndicated finance serves as a form of financing where multiple banks or financial institutions agree to work together and take part in a transaction where each offers a percentage of the principle financing firm to the borrowing party.
According to Cumming, Sapienza, Siegel, & Wright, (2009) Islamic syndicated financing borrows the same model as conventional syndicated finance where the participating financing agents appoint a lead bank responsible for orchestrating the syndication in addition to supervising the activities of preparing and documenting, and closing the deal. In most instances, the lead bank also serves as one of the participating financial institutions. During the syndicate financing process, the borrower only deals with the lead bank and therefore does not engage in any form of communications or dealings with the other participating financial institutions as the lead bank solely acts on behalf of all the participating financial institutions. As earlier indicated, Islamic syndicated financing takes up the form of the conventional syndicate finance with the main contrast being that the former its employment is limited to acceptable practices of the Shariah law. One of the unique features Islamic syndicated finance is that it lacks the aspects of interest. In the place of interest, Islamic syndicated finance is characterized by leases and trades of tangible assets where the assets are the ones associated with the generation or growth of any value in the transaction. One of the major advantages that is associated with Islamic syndicated finance is that it offers significant benefits to both the borrowing and lending parties.
Mohamad, and Saeed, (2017) provides that one of the most common Islamic syndicate financing products involves the issuance of Islamic bonds that are commonly referred to as investment Sukuk. Investment Sukuk are primarily certificates that hold a value that is equal to the individed shares of ownership to a variety of tangible assets, services and usufruct, or the ownership of a specific asset that is included in a given project or investment activity. The Islamic Financial Services Board defines Sukuk, otherwise referred to as ‘Islamic Bonds,” as certificates that represents the undivided ownership right of the holder in form of tangible assets or a business venture. Sukuk play a critical role in meeting the needs of liquidity management mobilization in addition to complying the demands of the Muslim investors who are normally apprehensive about investing in conventional bonds owing to the prohibitory nature of the Islamic law.
The popularity of Sukuk in the financing of large projects and enterprises especially in cases where a single party is unable to finance the project owing to the immense capital involved, complex risks associated with the venture or other challenging factors. The financing option forms an effective approach for investors who aim to deploy streams of capital and at the same time desire the ability to liquidate their position with ease in the event such a need arises. One of the underlying motivations for the above practice is that the investing parties normally envision the development of a secondary market for trading the Sukuk in the foreseeable future. Therefore, in the event that the financing parties require cash from the amount invested or a percentage of the same, it is convenient form them to trade their Sukuk holdings or part of the holdings and consequently regaining their investment in addition to any possible earning that is associated with the investment.
Specifically for banks and other financial institutions that are involved in the Islamic syndicated financing transaction, Sukuk offers a convenient means of meaning liquidity in the event any of the parties concerned is in need of disposing the excess liquidity that may have accrued over a given period of time. In such cases, the concerned financing party mainly purchases additional Sukuk. On the other hand, in the event the concerned financing is in need of liquidity, then they simply sell of their Sukuk plus the accrued additional value in the secondary market.
Additionally, Sukuk form an effective approach towards the equitable distribution of wealth among a number of financing parties and therefore enabling every player to benefit from the real profits that are associated with a given investment project or transaction. Consequently, the approach provides for the efficient transaction of wealth in a broad manner without necessarily favoring any party, which is essentially one of the primary purposes of an Islamic economic system. Moreover, the Sukuk offer a critical financial instrument for not only diversifying resources where financing institutions are able to spread their financial resources over multiple investment opportunities but also offer the necessary liquidity to both governments and institutions that require long term and funding sources for their capital intensive projects. Furthermore, Sukuk play a critical role in enhancing the quality of the Islamic Financial markets as they complement the role that is played by shares and consequently offering an alternative in the stock exchange whereby funds are able to move much freely and easily. In the process, it is possible to meet the needs of the state in a much effective manner as far as the financing of infrastructure projects in comparison to the overreliance of bonds, treasury bonds, and public debt.
Al‐Salem, (2009) finds that as far as derivatives and venture capital financing is concerned, the ability of Islamic syndicated financing to play the respective roles is based on the profit sharing principle. Derivatives are defined as those contracts that derive their value from the performance of an underlying entity. The underlying entity can take a variety of forms such as an index, asset, or interest rate. In retrospect, the Islamic financing and banking system comprises of a variety of Islamic financing products that conform to the Islamic law. All the fundamental financial instruments are also employed for the purposes of Islamic syndicated financing. The Islamic financial instruments are normally based on the mark up principle or the profit and loss sharing principle. The table below illustrates some of the common Islamic financial instruments. Important to note is that the table is not exhaustive since Islamic financing is characterized by the freedom of contracts that provide for an almost infinite design of forms of transactions and financial instruments.
Both the Mudarabah and the Musharakah serve as equity investments and therefore, lie in accordance with the profit sharing principle. Accordingly, the financing entities are entitled to a stake in the profits or losses that are experienced by the borrowing party and whose ratio is mainly defined by the contractual agreement. The rate of profit is mainly calculated as a percentage of the total profits made as opposed to a lump-sum payment. Therefore, in most cases the financing instruments or products also take up the form of derivatives whereby the amount of the return is mainly based on the performance of the underlying entity.
The Mudarabah financing product places the duty of financing the underlying entity on the financial institutions. Therefore, in the event the entity makes a loss, the financing institutions that are involved in the syndicated financing bear all the losses. The borrowing party, on the other hand, provides the relevant labor and expertise and thereby having all the freedom to manage the freedom. However, the borrowing party can be made responsible for the losses in the event the losses are as a result of negligence or mismanagement. The Musharaka approach to financing normally resembles venture capital. The various financial institutions involved in the syndication financing group are not the sole sources of financing as other parties such as the borrower can also contribute capital to finance the project or investment opportunity. The profit sharing structure is in accordance with both the performance of the project under finance and the capital contribution of each party concerned. Moreover, it is also possible to exercise the voting rights in accordance with the share held at the equity capital of the borrowing firm.
The research paper is mainly based on both the qualitative and quantitative research methodologies. As part of the qualitative research the paper seeks to identify the opinions and experiences of market players in the Saudi Arabian financial industry and especially as far as Islamic syndicated financing is concerned. On the other hand, as part of quantitative research, the paper aims to identify the existing trends and prevalence of Islamic syndicated financing.
Study Design and Data Collection
The study design adopted for the research is the systematic review design. The approach mainly involves performing a comprehensive review of the existing literature and specifically focusing on research studies that address the topic at hand. As part of the research design, the data collection method mainly involves visiting the nearest library including gaining access to internet based databases that contain articles, books, and other documents that touch on the topic at hand.
The data analysis process mainly involved using the data collected to identify the prevailing common concepts and trends in the existing literature to come up with a comprehensive review of literature.
Discussion and Conclusion
The comprehensive literature review provides that syndicated financing is one of the growing financing methods that have gained popularity in the Islamic financial market over the past decades. Nations such as Saudi Arabia that are dedicated Islamic states are characterized by unique financial systems that are in accordance with the Islamic law since the law transcends aspects of the society and hence the special design of the Islamic syndicated finance. The Islamic syndicated finance resembles the conventional syndicated financing that is practiced in other parts of the world where multiple banks including other financial institutions group together to offer financing to a given borrowing party. The underlying difference is that the former is in accordance with the Sharia law and therefore, does not recognize any increase in value that is solely associated with the financial transaction. The products and services associated with the Islamic syndicated finance take up a variety of forms with the most prominent being the Sukuk, Mudarabah and Musharakah.
Al‐Salem, F. H. (August 28, 2009). Islamic financial product innovation. International Journal of Islamic and Middle Eastern Finance and Management, 2, 3, 187-200.
Cumming, D., Sapienza, H. J., Siegel, D. S., & Wright, M. (December 01, 2009). International entrepreneurship: managerial and policy implications. Strategic Entrepreneurship Journal, 3, 4, 283-296.
Kuforiji, J. O., Abugri, B. A., & Andoh, S. K. (2014). Essentials of Money, Banking and Financial Institutions: With Applications to the Developing World. Blue Ridge Summit Lexington Books
Mohamad, M. T., & Saeed, M. T. (2017). Does Inter-Bank Investments Restraints Financing Performance of Islamic Banks? Strategic Financing Journal, 3, 6, 203-219.
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