What Is Islamic Finance?

RELATED BOOK
Islamic Finance For Dummies

By Faleel Jamaldeen

Islamic finance is a financial system that operates according to Islamic law (which is
called sharia) and is, therefore, sharia-compliant. Just like conventional financial systems,
Islamic finance features banks, capital markets, fund managers, investment firms, and
insurance companies. However, these entities are governed both by Islamic law and the
finance industry rules and regulations that apply to their conventional counterparts.

Although the Islamic finance industry itself is quite young, Islamic theories of economics
have existed for more than a millennium; by the mid-12th century, in fact, many Muslims
scholars had presented key concepts of Islamic economics that are still relevant today.

But political and social turmoil put the brakes on Islamic finance for a very long time; only in
the 20th century did Muslim scholars and academics seriously begin to revisit these topics
(and, in doing so, set the stage for the modern Islamic finance industry to emerge in the
1970s).

The search for balance

Islamic economics is based on core concepts of balance, which help ensure that the motives
and objectives driving the Islamic finance industry are beneficial to society.

 Balancing material pursuits and spiritual needs

 Balancing individual and social needs

The belief that Allah is the owner of all wealth

A core concept of Islam is that Allah is the owner of all wealth in the world, and humans are
merely its trustees. Therefore, humans need to manage wealth according to Allah’s
commands, which promote justice and prohibit certain activities.

At the same time, Muslims have the right to enjoy whatever wealth they acquire and spend in
sharia-compliant ways; they don’t need to feel shame about being wealthy as long as their
behavior aligns with Islam.

The promotion of a responsible free-market economy

A Muslim believes that Islam doesn’t restrict economic activity but instead directs it toward

responsible activity that benefits other people, protects the earth, and honors Allah. In other
words, Islam allows for a free-market economy where supply and demand are decided in the
market — not dictated by a government. But at the same time, Islam directs the function of
the market mechanism by imposing specific laws and ethics.

A key purpose for imposing these laws and ethics is to promote social justice; Islam and
social justice are inseparable. Therefore, social justice is a key concept of the Islamic finance
industry.

Islam tries to achieve social justice in the economy in many ways:

 Promoting adherence to Islam

 Requiring zakat (taxing the property of people who acquire wealth and distributing
that tax to people in need)

 Defining the state’s obligations

 Prohibiting usury (interest)

 Encouraging shared risk

Islamic firms follow a set of key principles

Based on the core concepts of Islamic economics, Islamic finance institutions adhere to
certain principles that distinguish them from conventional finance:

 Prohibiting interest (riba)

 Steering clear of uncertainty-based transactions (gharar)

  Avoiding gambling (maysir or qimar)

 Avoiding investment in prohibited industries

Islamic finance is a global financial system that complies with sharia (Islamic law) — a

code of conduct that guides all aspects of Muslim life. Sharia prohibits certain elements
that are common in conventional finance, such as interest and speculation. As the
world’s Muslim population increases, the demand for Islamic financial firms and
products is growing dramatically. Key Sharia Principles and Prohibitions in Islamic
Finance

Sharia law differentiates Islamic finance from conventional finance. The Islamic financial
system is constructed on economic concepts specified by sharia — a code of conduct that
guides Muslims (the followers of Islam) in social, economic, and political matters. Sharia
promotes balance and justice and discourages behaviors of excess. Some of the core ideas
promoted by sharia include the following:

 Allah (God) is the owner of all wealth. Humans are merely the trustees of wealth,
which belongs to Allah. Humans must manage wealth according to Allah’s
commands, which promote justice and prohibit certain activities, including wasting or
destroying resources. Muslims have the right to enjoy whatever wealth they acquire
and spend in sharia-compliant ways.
 Material pursuits must be balanced with an individual’s spiritual needs. A
Muslim’s economic activities and pursuit of wealth should balance with the spiritual
aspects of life. Economic activity conducted according to sharia is, itself, an act of
worship, but finding balance between economic activities and spirituality is key. A
Muslim is expected to seek moderation in the material world — to avoid being either
miserly or too materialistic.
 An individual’s needs must be balanced with society’s needs. A Muslim needs to
consider society in general when enjoying Allah’s bounties. These considerations
include promoting justice in all economic activities, remembering that all people have
mutual responsibility for all others, and using the earth’s resources wisely.
 Economic transactions should take place within a just, responsible, free-market
economy. Islam does not restrict economic activity but instead directs it toward being
responsible to other people, to the earth, and to Allah. Islam allows for a free-market
economy where supply and demand are decided in the market, but it directs the
function of the market mechanism by imposing specific laws and ethics. A primary
 purpose for imposing these laws and ethics is to promote social justice: a balance in
which wealth is not accumulated only by a few while most others suffer.

In support of these principles, sharia prohibits business transactions based on the following:

 Interest: Riba, the Arabic word for interest, means to increase, grow, or multiply into
more than what would be due. Riba is prohibited by Islam because it creates societal
injustice; in a riba-based transaction, the owner of the wealth gets return without
making any effort, and the borrower carries all the risk.
 Uncertainty: The Arabic word gharar means uncertainty or to cheat or delude.
Transactions based on gharar are unclear or ambiguous; not everyone involved knows
what to expect and can make an informed decision. Gharar exists when two parties
enter a contract and one party lacks complete information or when both parties lack
control over the underlying transaction.
 Gambling: Two Arabic words — maysir and qimar — refer to transactions that
involve gambling. Maysir is the acquisition of wealth by chance instead of by
effort. Qimar refers to a game of chance. Both types of transactions are based on
uncertainty; no one can know how a gamble will pay off.
 Prohibited products and industries: Islam prohibits products and industries that it
considers harmful to society and a threat to social responsibility. Examples include
alcohol, pork, prostitution, pornography, tobacco, and any products based on
uncertainty or gambling.

Islamic Financial Products Based on Sharia-Compliant Contracts

In accordance with Islamic law (sharia), Islamic financial products are based on specific

types of contracts. These Sharia-compliant contracts support productive economic activities
without betraying key Islamic principles as some conventional financial products do. Sharia-
compliant contracts cannot create debt, cannot involve the payment of interest, and must
provide for a sharing of risk and responsibility between the involved parties.

To be valid, an Islamic contract must feature subject matter that is lawful, has value for a
Muslim, and is specific enough to avoid uncertainties. The service or asset described in the
contract generally must exist when the contract is being created, must be owned by the seller
(hence prohibiting short sales of stock, for example), and must be deliverable.

Here are some of the most commonly used contracts in Islamic finance:
 Contracts of partnership allow two or more parties to develop wealth by sharing
both risk and return:
o Mudaraba: One party gives money to another party, which invests it in a
business or economic activity. Both parties share any profit made from the
investment (based on a pre-agreed ratio), but only the investor loses money if
the investment flops. The fund manager loses the value of the time and effort
it dedicated to the investment. (However, the fund manager assumes financial
responsibility if the loss results from its negligence.)
o Musharaka: This contract creates a joint venture in which both parties
provide investment capital, entrepreneurial skills, and labor; both share the
profit and/or loss of the activity.
 Contracts of exchange are sales contracts that allow for the transfer of a commodity
for another commodity, the transfer of a commodity for money, or the transfer of
money for money:
o Murabaha: In this cost plus contract, an Islamic financial institution sells a
commodity to a buyer for its cost plus the profit margin, and both parties know
the cost and the profit in advance. The buyer makes deferred payments.
o Salam: In this forward contract, the buyer (or an Islamic financial institution
on behalf of the buyer) pays for goods in full in advance, and the goods are
delivered in the future.
o Istisna: This second type of forward sale contract allows an Islamic financial
institution to buy a project (on behalf of the buyer) that is under construction
and will be completed and delivered on a future date.
 Contracts of safety and security are often used by Islamic banks; these contracts
help individual and business customers keep their funds safe:
o Wadia: A property owner gives property to another party for the purpose of
safeguarding. In Islamic banks, current (checking) accounts and savings
accounts are based on the wadia contract.
o Hiwala: Debt is transferred from one debtor to another. After the debt is
transferred to the second debtor, the first debtor is free from her obligation.
This contract is used by Islamic financial institutions to remit money between
people.
 o Kafala: A third party accepts an existing obligation and becomes responsible
for fulfilling someone’s liability. In conventional finance, this situation is
called surety or guaranty.
o Rahn: A property is pledged against an obligation. A customer can offer
collateral or a pledge via a rahn contract in order to secure a financial liability.

Timeline: The Evolution of Islamic Finance

The modern Islamic finance industry is young; its timeline begins only a few decades ago.
But Islamic finance is evolving rapidly and continues to expand to serve a growing
population of Muslims as well as conventional, non-Muslim investors.

The core concepts of Islamic finance date back to the birth of Islam in the 6th century;
Muslims practiced a version of Islamic finance for many centuries before the Islamic empire
declined and European nations colonized Muslim nations. The modern Islamic finance
industry emerged only in the 1970s, in large part because of efforts by early 20th-century
Muslim economists who envisioned alternatives to conventional Western economics (whose
interest-based transactions violate Islamic law).

Here are some of the key events in the short history of the modern Islamic financial industry:

 In 1963, the Mit Ghamr Savings Bank in Egypt was opened, becoming the first
modern Islamic bank on record.
 Also in 1963, the Pilgrims Saving Corporation of Malaysia — although not a bank —
began to incorporate basic Islamic banking concepts.
 In 1975, the Islamic Development Bank opened in Saudi Arabia and gave the Islamic
finance industry an international presence. It recruited member countries and then
offered them financial products to promote economic and community development.
 In 1979, the first Islamic insurance (or takaful) company — the Islamic Insurance
Company of Sudan — was established. (Muslims cannot purchase conventional
insurance products because those products involve interest-based transactions,
uncertainty, and gambling, which are all prohibited by Islamic law.)
 In 1986, the Amana Income Fund, the world’s first Islamic mutual fund (which
invests only in sharia-compliant equities), was created in Indiana.
 In 1990, the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) was created to establish industry accounting and auditing standards.
  Also in 1990, the Islamic bond market emerged when the first tradable sukuk — the
Islamic alternative to conventional bonds — were issued by Shell MDS in Malaysia.
 In 1996, Citibank began to offer Islamic banking services when it established the Citi
Islamic Investment Bank in Bahrain.
 In 1999, the Dow Jones Islamic Market Index (DJIMI) was established, becoming the
first successful benchmark for the performance of Islamic investment funds.
 In 2002, the Malaysia-based Islamic Financial Services Board (IFSB) was established
as an international standard-setting body for Islamic financial institutions.
 In 2004, the Islamic Bank of Britain became the first Islamic commercial bank
established outside the Muslim world.
In total, more than 500 Islamic financial institutions have been established worldwide since
the 1970s, including about 300 Islamic banks. In the past two decades, the Islamic finance
industry has averaged growth of 14 percent per year, and its assets are estimated to be worth
$1 trillion. Islamic financial institutions are currently operating in 75 Muslim and non-
Muslim countries.

Obligasi Syariah atau biasa dikenal dengan Sukuk, kini menjadi salah satu alternatif pilihan
investor dalam berinvestasi yang cukup menarik. Pasalnya sukuk ini bisa memberikan imbal
hasil (return) yang lebih tinggi dari bunga deposito namun memiliki risiko yang relatif rendah
dengan prinsip-prinsip syariah.
Layaknya dengan obligasi konvensional, sukuk ini dapat diterbitkan oleh pemerintah ataupun
perusahaan (korporasi) dengan memiliki jangka waktu dan nilai imbal hasil tertentu.

Sukuk ini merupakan cerminan kepemilikan aset berwujud yang disewakan atau akan disewakan
dan bukan berupa surat hutang. Hal ini juga yang membedakan antara sukuk dengan obligasi
konvesional pada umumnya. 

Pada sukuk, imbal hasil yang diberikan adalah berupa uang sewa (ujrah) dengan persentase
tertentu sesuai dengan prinsip syariah Islam yang tidak mengandung unsur riba. Imbal hasil
sukuk ini juga akan dibayarkan secara rutin pada periode tertentu dan nilai pokok pinjaman akan
dibayarkan pada saat jatuh tempo. 
Kita dapat membeli sukuk ritel ini pada hampir seluruh bank-bank besar baik nasional maupun
asing, bank syariah, dan perusahaan sekuritas terpercaya (kredibel) yang menjadi agen penjual
sukuk.

Melalui agen penjual yang telah ditunjuk pemerintah, salah satu persyaratan pembelian sukuk
ritel adalah dengan menunjukan kartu tanda penduduk Indonesia (KTP), sebab sukuk ritel ini
hanya ditujukan bagi warga negara Indonesia (WNI). 
Pembelian sukuk (untuk seri-seri yang pernah diterbitkan) dapat dilakukan dengan minimal Rp5
juta dan berlaku kelipatan misalnya Rp10 juta, Rp15 juta, Rp20 juta, dan seterusnya hingga
maksimal pembelian Rp5 miliar.

Apabila membeli sukuk ritel pada masa penawaran, dan ketika pada saat penjatahan hanya
mendapatkan sebagian sukuk ritel yang dipesan, maka sisa dana dapat
dikembalikan (refund) oleh agen penjual ke rekening investor.
Dalam hal ini, kita juga dapat memperdagangkan (mentransaksikan) sukuk ritel di pasar
sekunder dengan harga pasar untuk mendapatkan keuntungan (capital gain).
Selain itu, apabila kita membutuhkan likuiditas keuangan sebelum jatuh tempo, sukuk ritel dapat
dijaminkan kepada agen penjual sukuk ritel yang menyediakan fasilitas ini untuk investor.

Sementara dari segi risiko, sukuk ritel ini cukup aman dan memiliki risiko gagal bayar yang
rendah karena instrumen investasi ini pembayarannya dijamin oleh pemerintah sesuai dengan
Undang-undang Surat Utang Negara (SUN) dan Undang-Undang APBN. 

Meski begitu, tidak lantas sukuk ini bebas dari risiko, ada risiko lain yang dapat muncul yakni
risiko pasar. Risiko pasar (market risk) terjadi akibat harga jual sukuk di pasar sekunder lebih
rendah daripada harga beli, sehingga menyebabkan investor akan mengalami kerugian (capital
loss). 
Untuk menghindari kerugian tersebut, sebaiknya investor tetap tenang dan tidak menjual sukuk
ritel. Apabila dapat sabar menunggu hingga jatuh tempo, nominal pokok sukuk ritel akan
dikembalikan secara utuh 100 persen. 

Karena itu, sebelum kita berinvestasi pada sukuk ritel ini, sebaiknya kita mempelajari
karakteristik mengenai produk investasinya terlebih dahulu. Hal ini untuk memahami seluk beluk
berinvestasi pada sukuk ritel sehingga hasil dari investasi ini dapat menguntungkan.

Jenis Sukuk
1. Sukuk Ijarah 
Sukuk yang diterbitkan berdasarkan perjanjian atau akad ijarah, di mana satu pihak bertindak
sendiri atau melalui wakilnya menyewakan hak manfaat atas suatu aset kepada pihak lain
berdasarkan harga dan periode yang disepakati, tanpa diikuti perpindahan kepemilikan aset itu
sendiri.
2. Sukuk Mudharabah
Sukuk yang diterbitkan berdasarkan perjanjian atau akad mudharabah, di mana satu pihak
menyediakan modal (rab-al-maal/shahibul maal) dan pihak lain menydiakan tenaga dan keahlian
(mudharib), keuntungan dari kerjasama tersebut akan dibagi berdasarkan proporsi perbandingan
(nisbah) yang disepakati sebelumnya.
Kerugian yang timbul akan ditanggung sepenuhnya oleh pihak penyedia modal, sepanjang
kerugian tersebut tidak ada unsur moral hazard (niat tidak baik dari mudharib).
3. Sukuk Musyarakah
Sukuk yang diterbitkan berdasarkan perjanjian atau akad musyarakah, di mana dua pihak atau
lebih bekerjasama menggabungkan modal untuk membangun proyek baru, mengembangkan
proyek yang sudah ada, atau membiayai kegiatan usaha.
Keuntungan maupun kerugian yang timbul ditanggung bersama sesuai dengan jumlah
partisipasi modal masing-masing pihak.

4. Sukuk Istishna
Sukuk yang diterbitkan berdasarkan perjanjian atau akad istishna, dimana para pihak
menyepakati jual-beli dalam rangka pembiayaan suatu proyek atau barang.
Adapun harga, waktu penyerahan dan spesifikasi proyek/barang ditentukan terlebih dahulu
berdasarkan kesepakatan.
Pebedaan Obligasi Konvensional dan Syariah
Obligasi konvensional, keuntungannya di dapat dari besaran bunga yang ditetapkan,
sedangkan pada obligasi syariah, imbal hasil yang diberikan adalah berupa uang sewa
(ujrah) dengan persentase tertentu sesuai dengan prinsip syariah Islam yang tidak
mengandung unsur ribaS