The paper 'Islamic Banking and Finance' is a great example of a Finance and Accounting Essay. Financial systems have become more critical in the modern economy to facilitate the efficient allocation of resources. Financial intermediation is the core part of this financial system. This makes the financial intermediaries look for various ways they can perform their intermediation responsibility between the suppliers and users of funds. They gather and process information about the economic activities of various entities. Their main functions are asset transformation, brokerage, risk transformation, and conducting orderly payments. Asset transformation is the process of matching the demand for and supply of financial assets and liabilities.
It also includes transforming the maturity scale and looking for the financial assets and liabilities of the ultimate lenders and borrowers. Financial intermediation in the Islamic world has an established history record and had contributed significantly to economic development over time. ‘ Sarrafs’ were financiers in early days who played the role of the traditional and fundamental functions of a conventional financial institution, for example, intermediate between the lenders and borrowers, operating a secure and dependable domestic and cross border payment system, providing services such as the issuance of promissory notes and letters of credit to customers.
Financial historians equate the functions of Sarraf as that of modern banks. Sarraf's operated through a well-coordinated network and functioning markets. History has it that financial intermediaries in early Islamic days helped one another to overcome liquidity deficiency on the ground of mutual understanding borrowers. The Shariah laws present a set of intermediation contracts that are meant to assist in the execution and financing of efficient and transparent economic activities.
These contracts are adequate to offer a wide range of banking services. This led to the establishment of the world’ s first Islamic bank back in 1985, although it is only in the last ten years that Islamic finance has become popular with many people especially outside the Middle East region (Watts, para3). To be able to purchase four John Deere tractors at $100 000, three new plows at $20 000 and cane cutter at $75 000 Rafiq and Sarah can go for an Islamic financial product called murabahah. This is a sale contract at a profit markup.
Under murabahah there is a sales contract facility called bay mu’ ajjal. In this case, the bank sells goods and property against deferred payments. Its distinguishing characteristic from cash sale is that the payment can be made later after supply. The future payment may not necessarily be higher than the cash price and therefore it might turn to be friendly. In addition, there is another sale contract under murabahah called bay al-murabahah where the seller declares the actual cost incurred in bringing the commodity to its current state and then both sellers and the buyer agree on adding an agreed profit margin.
In other words, this is a mutual buying and selling contract. In this case, no financial intermediation is engaged. Rafiq and Sarah should know that there is a mode of finance that has been created which combines the two concepts. The bank receives an order from the client to purchase a certain commodity or asset at a particular price. The client then enters into an agreement with the bank that he will buy the product once the bank has bought it though at a rescheduled price which incorporates a pre-arranged profit margin in favor of the bank.
It is at the discretion of the client and the bank to agree whether the client should pay as a lump sum or installments (Islamic Financial Products, para4).
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Watts, C., (2010): Is Islamic finance at tipping point. Retrieved 21st May, 2010 from: http://www.economist.com/sponsor/qfc/index.cfm?pageid=article10