Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 25Takaful

Takaful offers an exceedingly interesting subject of study for Islamic finance. It somehow brings to surface underlying currents in the whole problem of financial intermediation. Banking, asset management, fund management, wealth management, and even takaful (not insurance) reveals a set of agency contracts between those who supply funds and those who manage them. This underlying agency contract is not so visible in Islamic banking as it is in takaful and asset management. From one point of view takaful is a form of asset management,¹ where investors are replaced with participants whose funds or contributions are pooled together to cover participants for a negative event.

In Islamic banking, depositors' funds are pooled together and used to finance various credit- and equity-based contracts and purchase financial assets. Bankers do not earn an agency fee; rather they earn a spread between the funds they employ and the funds they deploy. They also share in the returns earned from investment in assets. Shareholder funds are, however, segregated from depositors' funds, a unique contribution of Islamic finance, and typically shareholders are not meant to earn returns from credit financing as then shareholders would be competing with depositors for business.

Contract of Agency

Takaful is a different beast altogether. It is a scheme by virtue of which individuals can protect themselves from the financial losses incurred by specific events. Figure 25.1 shows some ...