Islamic Finance Institutions offer products that are in line with Shariah rules to meet the needs of Muslim customers. Islamic financial products and services are different from widely available conventional options. In this article, we will discuss 4 common Islamic finance products available in the market today.
1- Islamic Banking Products
In general, there are two types of Islamic financial products: equity-type contracts (PLS) and price mark up (similar to debt contracts). Both have connections to real-world economic activity.
Equity contracts are either:
- Mudarabah, or trust financing; The bank is the provider of the capital, and the other party will carry out the business. Furthermore, the profit generated from the company is shared in a predetermined ratio between the bank and the entrepreneur. If there is any loss, the bank has to handle it unless caused by negligence or the violation of the terms of the contract. Overall, the bank passes on this loss to the depositors.
- Musharakah, which is related to partnership; In this contract, partners share in the profits and losses of a business. Since Shariah prohibits interest in lending, Mushakarah allows profit to be distribution among the partners on pre-agreed ratios. In contrast, each partner shares the losses in proportion to their contribution.
In price mark up (debt) contracts, a bank finances the purchase of assets or services in exchange for a negotiated profit margin. The most widely used instruments are:
- Murabahah: cost plus profit margin
- Ijarah: lease financing
- Istisna: commissioned manufacture
- Salam: advance purchase
2- Islamic Financing Products
The most common financing features offered by Islamic bank involves two main sectors, namely retail sector and commercial sector.
Retail Financing
The term “retail financing” refers to financial activities that focus on providing service to individual customers rather than businesses. Retail finance is designed to meet basic individual needs such as home and vehicle purchases, as well as access to cash. Some Islamic retail financing instruments and contracts are listed below.
- Home financing; usually use the contract of Bay’ Bi Thaman Ajil (BBA), Musharakah Mutanaqisah (diminishing partnership), and Istisna.
- Vehicle financing: usually use the contract of Al Ijarah Thumma Al Bay’ (Islamic hire purchase)
- Personal financing: Bay Al Inah, Qardh (interest-free loan), and Tawarruq
- Islamic credit card: usually based on Ujrah or Tawarruq
Commercial or Corporate Financing
On the other hand, corporate financing is tailored to the specific needs of businesses, which may differ from those of retail customers. In addition to debt-based products, Islamic banks also offer lease-based and equity-based financing options for corporate financing. Here are the contracts used for corporate financing:
- Corporate financing based on sales, such as Murabaha financing, commodity Murabaha or Tawarruq financing, Istisna financing, and Salam financing.
- Corporate financing based on leases, such as Al Ijarah Al Muntahiyah Bi Al Tamlik
- Equity-based financing, including Mudharabah and Musharakah
3- Islamic Bonds – Sukuk
A Sukuk is Islamic bond-like security that is compatible Islamic Finance principles. Since bonds are based on interest, they have traditionally been impermissible for Muslim investors. However, Islamic scholars and financial institutions have developed Sukuk, which is not debt and has no element of interest. Sukuk represents ownership in a tangible asset. And every asset that supports a Sukuk must be Sharia-compliant.
4- Islamic Insurance – Takaful
Takaful is an alternative to conventional insurance. Takaful operates based on the concept of tabarru’ (donation). Tabarru is a donation for a non-commercial purpose and to assist other participants in times of need. It is a major Islamic insurance type where participants put their money into a pool system to mutually help each other in the period of any loss or disaster. In addition, Takaful works relying on the principle of cooperation (ta’awun). In essence, every participant of the fund is cooperating and protecting each other through their contributions. Takaful fixes the issues related to conventional insurance by creating a risk shared fund that invests in only Shariah-compliant investments.
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