Faculty of International Business

and Humanities (FIBH)

MBA Program

Corporate Finance

Islamic
Financing
Shariah-Compliant Finance
 Faculty of International Business
and Humanities (FIBH)

MBA Program

Spring 2024

Subject

Corporate Finance
Project

Islamic Financing

Lecturer

Dr. Menan Etab

Prepared By

Name ID

Mohamed Ali 310202370

Hassan Khatab 310202353
Osama El-Khouly 310202387
Mohamed Gamal 310202373
Contents:
▪ Introduction
▪ Main differences between Islamic financing and Conventional financing
▪ Exploring Islamic Financial Contracts: A Comprehensive Overview
▪ Ethical Finance and Risk Management: Contrasting Dynamics in Conventional
and Islamic Markets
▪ Unveiling Sukuk: Sharia-Compliant Tools for Islamic Capital Markets
▪ References
Introduction
Islamic finance operates on the principle that money should not hold intrinsic value but should
serve as a medium of exchange for goods and services. Consequently, profiting solely from
money itself is forbidden, as is involvement in interest transactions. Additionally, Islamic
finance emphasizes ethical investment practices, avoiding industries deemed harmful such as
alcohol, tobacco, and gambling. It promotes partnership arrangements where both profits and
risks are shared, fostering cooperation between individuals and businesses.

Over the past two decades, Islamic finance has grown worldwide due to financial system
reforms, more liberal capital movement, and increased integration of financial markets.
However, creating a complete Islamic financial system is still in its early stages, facing
challenges related to financial instruments, market infrastructure, and regulatory frameworks.

Islamic Finance Assets Growth ( 2014 -

2020, USD Billion)
6000

5000

4000

3000

2000

1000

0
2015 2015 2016 2017 2018 2019 2020 2025
(Projected)

Islamic finance has emerged as a significant force within the global financial landscape,
offering an alternative model guided by Sharia principles. Its modern incarnation traces back
to pioneering experiments in the early 1960s, notably the Mit-Ghamr Islamic Saving
Associations in Egypt and the Pilgrims Fund Corporation in Malaysia. These initiatives
mobilized Muslim savings, providing returns in compliance with Sharia, and witnessed
exponential growth, setting the stage for the expansion of Islamic finance.

The late 1970s marked the formal establishment of Islamic banking institutions, with the
founding of major entities like the Dubai Islamic Bank. Subsequently, countries such as
Pakistan, Iran, and Sudan began aligning their financial systems with Sharia principles. The
establishment of the Islamic Development Bank in 1975, along with the subsequent rise of
comparable institutions, highlighted the increasing significance of Islamic finance.

Supporting infrastructure, including regulatory bodies and standard-setting institutions, has

evolved in tandem with the industry's growth. Organizations like the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services
Board (IFSB) have played pivotal roles in issuing standards and guidelines to govern Islamic
financial transactions globally.

Despite its expansion beyond Muslim-majority countries, Islamic finance remains concentrated
in certain regions, notably Iran, Malaysia, and Gulf Cooperation Council (GCC) countries. Its
principles have sparked global interest and adoption, with over 300 Islamic financial
institutions operating in more than 70 countries. However, challenges persist, including socio-
political instability, regulatory frameworks, and a shortage of trained personnel.

Distribution of Islamic financial asset value worldwide

in 2022, by country(in billion U.S. dollars)

Iran
Saudi Arabia
Malysia
United Arab Emirates
Qatar
Kuwait
Indonesia
Bahrain
Turkey
Bangladesh

0 200 400 600 800 1000 1200 1400 1600

Egypt, considered the birthplace of Islamic finance, has seen a slower adoption rate compared
to other regions due to governmental policies and regulatory hurdles. Despite popular support,
the government's stance has been ambivalent, hindering the industry's progress. Challenges
such as asset-liability management, liquidity management, and a lack of trained personnel
underscore the need for comprehensive research and comparative analysis between Islamic and
traditional banking systems.

This paper aims to provide an overview of Islamic finance, main differences between Islamic
and Conventional financing, Islamic financial tools, ethical Finance and Risk Management.
Main differences between Islamic financing and Conventional financing:

Islamic finance and conventional finance are two distinct systems with fundamental differences
in principles, structures, and operations. Here's a detailed analysis highlighting the main
differences between the two:

1- Principles and Ethics:

Islamic Finance: It operates on Shariah principles, which prohibit activities involving
interest (riba), uncertainty (gharar), gambling (maysir), and investment in unethical
businesses like alcohol, gambling, and pork. Transactions must be based on ethical and
moral principles.
Conventional Finance: It operates based on profit maximization and interest-based
transactions. The primary objective is to maximize shareholder wealth without explicit
consideration for ethical or religious principles.
2- Interest (Riba):
Islamic Finance: Interest is strictly prohibited as it is considered exploitative and
unfair. Instead of lending money at a pre-determined interest rate, Islamic finance uses
profit-sharing arrangements (Musharakah), leasing (Ijarah), Cost plus (Murabahah) and
partnership contracts (Mudarabah).
Conventional Finance: Interest is a core component, with loans and debt instruments
structured around fixed or variable, simple or compound interest rates.
3- Risk-sharing:
Islamic Finance: Emphasizes risk-sharing between parties. In Islamic banking, profits
and losses are shared between the lender and the borrower, promoting a more equitable
distribution of risk.
Conventional Finance: Risk is often transferred entirely to the borrower, with lenders
seeking to minimize their exposure through collateral and interest rates.
4- Asset-Backed Financing:
Islamic Finance: Encourages asset-backed financing, where transactions must be
linked to tangible assets or services. For example, in Islamic mortgages, the property is
co-owned by the bank and the buyer until the loan is paid off.
Conventional Finance: While assets can be used as collateral, the focus is often on
creditworthiness and cash flows rather than direct asset backing.
5- Speculation and Uncertainty:
Islamic Finance: Prohibits transactions involving excessive uncertainty (gharar) and
speculation (maysir). Contracts must be transparent and based on tangible assets or
services.
Conventional Finance: Speculative activities such as derivatives trading are common,
where the underlying asset may not be tangible, and transactions are based on future
market movements.
6- Regulatory Framework:
Islamic Finance: Governed by Shariah boards that ensure compliance with Islamic
principles. Regulatory bodies in Islamic countries may have specific guidelines for
Islamic financial institutions.
Conventional Finance: Regulation varies by country but generally follows standard
banking and financial regulations without religious considerations.
7- Social Responsibility:
Islamic Finance: Emphasizes social responsibility and economic justice. Islamic
financial institutions are encouraged to support community development and avoid
investments that harm society or the environment.
Conventional Finance: Social responsibility may be a consideration for some
conventional financial institutions, but profit maximization typically remains the
primary goal.
8- Innovation and Flexibility:
Islamic Finance: While rooted in centuries-old principles, there is room for innovation
within the framework of Shariah. Financial institutions continue to develop new
products and structures that comply with Islamic principles.
Conventional Finance: Generally more flexible and innovative, with a wide range of
financial products and services catering to various needs and risk appetites.
Exploring Islamic Financial Contracts: A Comprehensive Overview

1- Murabaha
Murabaha is a fundamental concept in Islamic finance and represents a common
method of asset financing. It's a sale contract wherein the seller discloses the cost of the
goods and adds a known profit margin on top of that cost (Hassan et al., 2017).
Historical Background
The concept of Murabaha has its roots in Islamic jurisprudence and is designed to
comply with Sharia law, which prohibits the payment or receipt of interest (riba).
Murabaha evolved as a solution for Muslims to engage in trade and financing in a way
that aligns with their religious beliefs.
How Murabaha Works
In a Murabaha contract, the buyer requests the bank to purchase an item on their behalf.
The bank then buys the item and sells it to the buyer at an increased price, which
includes the original cost plus a profit margin. The markup is transparent and agreed
upon at the time of the contract. The buyer can make the payment in a lump sum or in
installments, depending on the agreement (Wulandari et al., 2016).
Key Features
Transparency, Fixed Profit, Asset-Based and Deferred Payment.

2- Mudaraba
Mudaraba, also known as Qirad, is a unique form of partnership in Islamic finance
where one party provides the financial capital and the other provides expertise and
management. It's a trust-based contract that facilitates profit-sharing investments
(Yustiardhi et al., 2020).
Historical Background
Mudaraba has its origins in the early Islamic period and was a common way for
merchants to finance their trade voyages. The financier, known as Rab al-Mal, would
provide capital to a trader, or Mudarib, who would then use this capital to engage in
business activities. This partnership allowed for the sharing of profits while maintaining
compliance with Islamic principles that prohibit interest (riba).
How Mudaraba Works
In a Mudaraba contract:
 ▪ The Rab al-Mal provides the entire capital needed for a business venture.
▪ The Mudarib manages and works on the project using their expertise.
▪ Profits are shared according to a pre-agreed ratio, which can be flexible and
negotiated.
▪ Losses, except those due to the Mudarib's misconduct or negligence, are borne
entirely by the Rab al-Mal.
Key Features
Risk Sharing, No Fixed Return, Management Autonomy and Ethical Investment.

3- Musharaka
Musharaka is an Islamic financial contract that represents a partnership or joint venture
where all partners contribute capital and share in the profits and losses of the enterprise.
It's a form of business collaboration that aligns with Islamic principles, particularly the
prohibition of interest (riba)(Rammal, 2004).
Historical Background
Musharaka stems from the Arabic word "sharing" and is rooted in Islamic
jurisprudence. It's designed to facilitate business and trade in a way that adheres to
Sharia law, which emphasizes ethical transactions and social justice. Historically,
Musharaka contracts have been used to finance trade expeditions, agricultural projects,
and other commercial ventures without the involvement of interest-based lending.
How Musharaka Works
In a Musharaka agreement:
▪ Partners contribute capital in various forms, such as cash, property, or expertise.
▪ They agree to share profits and losses based on their capital contribution.
▪ All partners have a say in the management and decision-making processes of
the business.
Key Features
Equity Participation, Shared Management, Profit and Loss Sharing and Flexibility.

4- Istisna
Istisna is a contractual agreement found in Islamic finance, which involves a transaction
where goods are ordered to be manufactured or constructed with specific stipulations
and delivered at a later date. This contract is particularly significant for financing large
construction projects or manufacturing of goods (Al-Bashir & Al-Amine, 2001).
 Historical and Legal Background
Istisna has its origins in Islamic jurisprudence and is recognized by various schools of
Islamic thought. It is a contract that allows for the acquisition of goods by specification,
where payment can be made at the time of the contract, gradually in accordance with
progress, or upon completion. It is considered permissible by Hanafi jurists out of
Istihsan (juristic preference) and by Shafi'i jurists when it meets the conditions of a
Salam contract.
How Istisna Works
In an Istisna contract:
▪ The buyer (or the one who requires the manufacturing) places an order for a
specific asset to be produced.
▪ The manufacturer (or seller) agrees to produce the asset according to the agreed
specifications.
▪ Payment is typically made in installments, linked to project milestones or upon
delivery.
Key Features
Customization, Deferred Delivery and Payment Flexibility.

5- Salam
Salam, also known as Bai Salam, is a forward sale contract unique to Islamic finance.
It's a mechanism that allows sellers to receive advance payment for goods that are to be
delivered at a future date. This contract is particularly beneficial for agricultural
producers who need funds before the harvest (Muneeza & Mustapha, 2020).
Historical Background
The Salam contract has a rich history within Islamic finance. It was introduced to
provide liquidity to farmers who needed funds in advance to grow their crops. Before
the prohibition of interest, farmers would rely on interest-based loans. However, with
the introduction of Salam, they could receive advance payment without the need for
such loans, which aligns with Shariah principles.
How Salam Works
In a Salam contract:
▪ The buyer pays the full price for the commodity upfront.
▪ The seller agrees to deliver the commodity at a specified future date.
 ▪ The goods must be clearly defined in terms of quality, quantity, and delivery
date to avoid ambiguity.
Key Features
Advance Payment, Deferred Delivery and Risk Mitigation.

6- Ijarah
Ijarah, derived from the Arabic term for "lease" or "rent," is a contract that plays a
pivotal role in Islamic finance, allowing for the use of assets without the need for
conventional interest-based lending (Hilmy et al., 2021).
Historical and Legal Background
Ijarah has been a part of Islamic jurisprudence for centuries, providing a structure for
leasing that complies with Sharia law. It's based on the principles of fairness and
transparency, ensuring that the terms of the lease are clear and mutually beneficial.
How Ijarah Works
In an Ijarah contract:
▪ The lessor (owner of the asset) agrees to lease the asset to the lessee.
▪ The lessee gains the right to use the asset for a specified period in exchange for
rental payments.
▪ Ownership of the asset remains with the lessor throughout the lease term.
Key Features
Asset Ownership, Fixed Rentals
Ethical Finance and Risk Management: Contrasting Dynamics in
Conventional and Islamic Markets

Navigating Financial Markets: A Comparative Analysis of Conventional and Islamic

Approaches

1- Nature of Investments:
▪ Conventional Capital Market: In a conventional capital market, investors can
invest in any sector they choose, regardless of whether the activities comply
with religious or ethical guidelines.
▪ Islamic Capital Market (ICM): The ICM adheres to Shariah principles, which
prohibit investments in sectors such as alcohol, gambling, and pork-related
businesses. Investments must align with Islamic ethical standards.
2- Risk-Sharing vs. Fixed Returns:
▪ Conventional Capital Market: Conventional investments often involve fixed
returns (e.g., interest-based bonds). Investors receive predetermined interest
payments.
▪ ICM: The ICM emphasizes risk-sharing. Instead of fixed returns, investors
participate in profit and loss sharing. For example, Sukuk (Islamic bonds)
represent ownership in an underlying asset, and returns are based on the asset’s
performance.
3- Prohibited Activities:
▪ Conventional Capital Market: Conventional markets allow various financial
instruments, including interest-bearing bonds, speculative derivatives, and
short-selling.
▪ ICM: The ICM prohibits interest (usury), speculation, and uncertainty (gharar).
It focuses on real economic activities and asset-backed transactions.
4- Regulatory Framework:
▪ Conventional Capital Market: Conventional markets operate under secular legal
systems and regulatory bodies.
▪ ICM: The ICM operates within a framework guided by Shariah principles. It
has specialized regulatory bodies that ensure compliance with Islamic finance
rules.
 5- Property Rights and Social Responsibility:
▪ Conventional Capital Market: Property rights are paramount, and individual
interests prevail.
▪ ICM: The ICM considers not only individual rights but also social
responsibilities. Investments should benefit society as a whole.

In summary, while both markets serve the same purpose of raising capital, the Islamic capital
market distinguishes itself through its adherence to ethical guidelines, risk-sharing principles,
and focus on real economic activities

Navigating Liquidity: Contrasts in Risk Perception and Management in Conventional

and Islamic Markets

Liquidity management in the Islamic Capital Market (ICM) involves unique considerations due
to its adherence to Shariah principles. Let’s explore some aspects of ICM liquidity
management:

1- Liquidity Risk Definition:

▪ Conventional Capital Market: Liquidity risk arises from inadequate market
conditions or stressed scenarios, affecting a bank’s ability to sell assets at
reasonable prices.
▪ ICM: In the ICM, liquidity risk also considers compliance with Shariah
principles. It involves managing liquidity mismatches while adhering to ethical
guidelines.
2- Tools and Mechanisms:
▪ Conventional Capital Market:
• Conventional markets use various tools for liquidity management,
including trading assets like stocks and meeting cash requirements.
• Well-developed money markets enable banks to minimize idle liquid
assets by putting funds to use.
▪ ICM:
• The ICM faces challenges related to the availability of Shariah-
compliant liquidity-risk-management tools:
• Limited supply of short-term Sukuk (Islamic bonds).
 • Insufficient tools meeting High-Quality Liquid Assets (HQLA) criteria.
• Possible overreliance on commodity Murabaha transactions1.
• Issues with interbank placements and foreign-currency instruments.
• Lack of reliable Sharī`ah-compliant lender-of-last-resort facilities and
collateral.
• Differing interpretations of Sharī`ah rulings.
▪ Important measures for ICM liquidity management include:
• Instruments and Sukuk issued by governments and central banks.
• Compatibility with HQLA requirements.
• Variety and diversity of instruments.
• A Sharī`ah perspective on tradability.
3- Unique Characteristics:
▪ Conventional Banks: They manage liquidity using a wide range of tools,
including interest-based instruments.
▪ Islamic Banks: They face unique challenges due to Shariah compliance,
avoiding interest-based instruments and focusing on risk-sharing and real
economic activities1.
4- Important Measures:
▪ Government and Central Bank Instruments: Governments and central banks
issue instruments and Sukuk that can serve as liquidity tools1.
▪ HQLA Compatibility: Ensure compatibility with HQLA requirements1.
▪ Variety and Tradability: Diverse instruments and a Sharī`ah perspective on
tradability is crucial.

In summary, while both markets aim to manage liquidity, the ICM emphasizes ethical
compliance and risk-sharing, making it distinct from conventional liquidity management
practices.
Unveiling Sukuk: Sharia-Compliant Tools for Islamic Capital Markets

Sukuk, often referred to as Islamic bonds, are financial instruments used in Islamic finance that
comply with Sharia principles. They have gained prominence in Islamic capital markets as an
alternative to conventional bonds. Here are the main features of Sukuk and how they are
utilized:

1. Asset-Backed Nature:

Sukuk are structured to be asset-backed, meaning they represent ownership interests in

tangible assets or services. Unlike conventional bonds that are essentially debt obligations,
Sukuk holders have a share in the ownership of the underlying assets. This feature provides
investors with a sense of security and transparency, as they can directly link their investment
to tangible assets.

2. Risk-Sharing Mechanism:

One of the fundamental principles of Islamic finance is the prohibition of interest (riba) and
the promotion of risk-sharing. Sukuk adhere to this principle by involving risk-sharing between
the issuer and the investors. Instead of receiving fixed interest payments, Sukuk holders share
in the profits or losses generated by the underlying assets. This risk-sharing mechanism aligns
with Islamic values and promotes fairness in wealth distribution.

3. Sharia Compliance:

Sukuk structures are designed to comply with Sharia principles, which prohibit involvement
in certain activities such as gambling, alcohol, and interest-bearing transactions. This
compliance is ensured through rigorous legal and Sharia advisory processes, which certify that
the Sukuk issuance and underlying assets are Sharia-compliant. As a result, Sukuk provide
Islamic investors with opportunities to invest their funds in accordance with their religious
beliefs.

4. Diverse Structures: Sukuk can be structured in various ways to accommodate different

financing needs and preferences. Common structures include Mudarabah (profit-sharing),
Ijarah (leasing), Musharaka (partnership), and Wakalah (agency). Each structure has its own
characteristics and implications for risk and return, allowing issuers to tailor Sukuk offerings
to suit their specific requirements.
In the Islamic capital markets, Sukuk serve as important instruments for raising capital while
adhering to Sharia principles. Governments, corporations, and financial institutions use Sukuk
to finance a wide range of projects, including infrastructure development, corporate
expansions, and government budget deficits. Furthermore, Sukuk provide investors with
opportunities to diversify their investment portfolios within a Sharia-compliant framework,
thereby contributing to the growth and stability of Islamic finance globally.
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