Use of Financial Instruments and Interaction with Islamic Financial Law

Abstract

This research provide an analysis of how financial instruments are used in markets, and to what extent they are related to Islamic financial law. Islamic law prohibits usury, uncertainty, and those transactions that involve ambiguity. Conventional finance on the other hand is debt based and involves a lot of risk. We used structured interview questionnaire, and experts from the field of conventional and Islamic finance were interviewed. Results of structure interview reveal that many things are common between Islamic and conventional finance such as rent for services in case of both conventional and Islamic lease. The Murabaha is somewhat similar to asset backed risky loan. The features of Mudaraba are closer to European option such that profits from Mudarabah offset call price. In addition the deposits are collected under both systems. This research also found that best financial instrument for increasing value of a firm is equity financing, while debt financing is not a good choice, because the later increases risk and decreases value of a firm. Swaps and forwards are used for hedging risks and saving the future. It is concluded that most of the conventional instruments are not prohibited, and they intersect at various points with Islamic financial law. The gap of two systems can be reduced by taking number of steps such as transferring ownership of a leased asset after first installments. Furthermore the gap can also be reduced if shares are offered for purchase of an asset at beginning, and when that asset begins to produce cash flows, then distributing profits equally, but the bank or organization providing services will be provided service charges.

Keywords: Islamic Financial Instruments, Conventional Instruments, Sukuk.