Halal investing has been an important topic for our readers. We often get questions on how to invest the Halal way and where to invest money without interest.
The Federal Reserve took drastic measures in June to flatten the highest U.S. inflation rate in four decades by instituting a 0.75-percentage-point rate increase. This increase to the Fed’s benchmark federal-funds rate is meant to combat the higher than an anticipated consumer price index.
With federal funds rates projected to reach past 3% in the coming year, that means financing rates could reach over 6%. Such elevated rates soar the cost of capital and acquisition fees, making it difficult for the average entrepreneur to perform in a bear market. Under these circumstances, here are ways that you can use Shariah trade financing (Islamic banking) as an alternative means of financing.
Islamic Banking In A Nutshell
Islamic banking or finance refers to financial transactions that comply with Shariah law and are founded on the precepts of Islam. These concepts are derived from the Quran, and the laws governing commercial transactions are known as fiqh al-muamalat. Islamic banking is formed on two fundamental principles.
1. The sharing of profits and losses.
2. The prohibition of collecting interest.
These two main fundamentals can make Sharia financing highly desirable to the entrepreneur. However, securing funding from countries within the Gulf Cooperation Council (GCC) reserves is not as simple as it sounds unless you follow the guidelines and present opportunities under the appropriate circumstances.
Generally speaking, Arabs prefer doing business with people they know and like, and for them building ties based on personal trust is essential since it creates a strong bond. In GCC business communities, who you are and who you know (in Arabic, wasta) are critical in business communities.
Wasta basically translates as “connections” or “influence,” and its exact translation in Arabic is “middle.” With this mode of banking, investing time to get to know and trust your business contacts is worthwhile.
The Fundamental Differentiations
There are numerous banking systems worldwide, but conventional and Islamic banking is the most well-known.
Conventional banking’s primary function is borrowing (either from the Federal Reserve or depositors) and lending this borrowed money to generate profit from the interest income.
In contrast, the Islamic financial system is founded on a partnership notion. In Islamic banking, shareholders, depositors and borrowers share proportionally in profits and losses. As a result, if the borrower defaults or does not generate a profit, the bank will not benefit either.
Therefore, Islamic financial organizations are typically more risk-averse in their investing strategies and consequently employ heavy due diligence before funding any venture. They also avoid businesses that may be related to economic bubbles.
The Funding Appetite
There are several GCC Investment enterprises and banks interested in funding the foreign initiative, but most of their investment mandates are standard across the board. Through years of partnering with GCC Funding sources, we have witnessed a higher interest in funding feasible projects at the growth stage.
Although these companies have a diverse portfolio of investments, in my experience, they are most focused on supporting initiatives in:
• Renewable energy projects like solar, hydropower, and wind.
• Real estate projects in the residential, commercial, and industrial sectors.
• Technology projects such as waste management and pharma-tech.
On the contrary, ventures involving goods or substances forbidden by the Quran, such as alcohol, gambling, and pork, are banned. Islamic banking can, thus, be viewed as a culturally different form of ethical investing.
Islamic Lending Types
Islamic banks mainly profit by charging a markup (known as murabahah) or equity participation (known as mudarabah), which requires a borrower to give the bank a piece of their profit.
Murabahah is comparable to a rent-to-own system in the non-Muslim world. Instead of charging interest, the seller/lender makes a religiously allowed profit on the sale of goods that enables the buyer to make payments over time; profits are based on the contractual terms between the borrower and the bank.
Mudarabah is more comparable to trustee finance or passive partnership, where there is no fixed rate of interest collected along with the principal of the loan. For example, a bank may loan money to a business with equity participation, and the venture would then give the bank a portion of its profit according to an agreed profit-sharing ratio (ratio of profit).
Some banks may also offer wadiah (safekeeping), musharaka (joint venture), and ijara (lease) as additional forms of Islamic banking and financing.
More recently, pioneering Shariah scholars established the foundation of modern riba-free banking, introducing a two-tier mudarabah model where the bank acts as a capital partner having the depositor on one side and the borrower on the other side. This notion led to the development of fixed-return models. In practice, fixed-return models, specifically the murabaha model, have become industry mainstays rather than supplements since their results are most comparable to those of interest-based finance models.
With this method of banking, the profit rate can be relatively lower than the interest rate, especially in a bear market, for the expected profit margins are narrower, and the federal rates are not driving the profit rates.
Islamic Banking Outlook
Despite the Covid-19 pandemic, Islamic assets managed to expand by over 10% in 2020. According to research published in 2020 by the Islamic Corporation for the Development of the Private Sector (ICD) and Refinitiv, Islamic financial assets expanded from $1.7 trillion in 2012 to $2.8 trillion in 2019 and are anticipated to reach approximately $3.7 trillion by 2024. This expansion is mainly attributed to the growing economies of Muslim nations (especially those that have benefited from oil price increases).
Globally, there are about 520 banks and 1,700 mutual funds that adhere to Islamic principles.
The Bottom Line
Sharia finance is a centuries-old practice that is gaining popularity worldwide, and Islamic finance’s ethical and economic precepts are attracting attention from outside the Muslim community. Given the expansion of Muslim countries, the globalization of trade, and the rising demand for affordable financing, this industry is anticipated to foster the growth and evolution of numerous firms over the next few years.
Originally published on www.forbes.com