Islamic Capital Markets: Theory and Practice

Preface

Islamic finance is based on Quran and Sunnah. It strictly prohibits interest (riba), positive or negative. No economic entity, be it individual, enterprise, state, bank, or central bank, is allowed to contract interest-based debt. Free-of-interest lending, called qard-hassan, is permitted. However, since this form of lending has no pecuniary reward for investors, it can be assumed to be negligible. Therefore, in contrast to conventional finance, interest-based credit1 plays no role in Islamic finance. Because credit is almost absent in Islamic finance, there is no credit expansion or contraction, no fixation of interest rate by the state, and no conflict between borrowers and creditors. Islamic finance can be defined as a two-tier financial system:

1. A 100 percent reserve depository and safekeeping banking system for domestic and international payments.

2. A profit-loss–sharing type of investment banking that places real savings directly in private or public projects, or indirectly via the stock market. Investors are shareholders.

The first system keeps money deposits (e.g., cash, gold, silver, etc.) and settles payments via clearing, withdrawals, and other forms of payments. The second system receives savings, which it invests in productive projects or in more liquid investments such as mutual funds or stocks. Depositors receive transferable or marketable shares that enable them to liquidate their investment if they chose to do so. They share in profits and losses, ...