AN OVERVIEW OF ISLAMIC CAPITAL MARKETS

Islamic capital markets are a crucial component of the Islamic financial system which supports the Islamic banking industry’s participation in investments. Currently, there are a variety of instruments offered by Islamic capital markets to satisfy the needs of people who intend to invest in line with Shariah principles. In this article, we present a concise summary of Islamic capital markets and discuss their relevance.

There are two distinct methodologies used to build contemporary Islamic financial goods and services. The first strategy entails selecting currently offered conventional goods and services that are usually seen as acceptable by Muslims, then altering them by getting rid of any parts that are forbidden by Shariah and adding any necessary modifications. The second strategy entails using numerous Shariah tenets to encourage the creation and innovation of novel goods and services.

The development of the Islamic financial services sector has led to the formation of a unique Islamic capital market where investments, financing activities, and products are structured in accordance with Shariah principles.

Before we discuss Islamic capital markets, let’s clear the air on what capital markets are in general.

Capital markets are a place where long-term debt instruments and government or corporate-issued shares are traded. They are markets where debt and equity are traded to give investors a way to raise funds to meet the financial requirements of a project.

WHAT ARE ISLAMIC CAPITAL MARKETS?

Islamic capital markets are components of a financial system that deals with raising capital using shariah-compliant securities and instruments as alternatives to conventional shares, bonds, and other long-term investments.

The fundamental difference between Islamic capital markets and conventional capital markets is the absence of Riba (interest) as it is forbidden under Islamic law. As a result, conventional debt instruments are not suitable as investment vehicles or as a means of raising funds for businesses.

To salvage this situation, Sukuk was created, which links the gains and cash flows of loan financing to a specific item being purchased, thus sharing the advantages of that asset. Investors can avoid the Sharia prohibition in this way and still benefit from the boons of debt.

Hence, Islamic capital markets are crucial to a nation’s overall economic growth and capital expansion as it makes it seamless for investors who lack the resources required to finance large projects to raise money without worrying about steep interest charges.

WHAT IS SUKUK?

Sukuk is an Islamic financial certificate — comparable to a bond in conventional banking — that complies with Islamic religious law. The issuer of a Sukuk effectively sells a certificate to an investor group and then uses the money to buy an asset in which the investor group has a direct partial ownership stake — since the conventional interest-paying bond structure is not permitted in Islam.

The current expansion of the Islamic capital market is dependent on the issue of Sukuk, which governments and businesses utilize to expand their financial operations. Hence, if Sukuk is not issued on the capital market, Islamic financial markets would remain stagnant. This is so because Sukuk is an adaptable financial tool for financing large projects that private citizens cannot afford to fund.

SIGNIFICANCE OF ISLAMIC CAPITAL MARKETS

The requirement to establish clear instructions on the kinds of stocks that meet Shariah standards is a major facet of the early establishment of the Islamic capital market. Specific standards established by Shariah scholars serve as a reference for the evaluation and identification of equities that adhere to Islamic law.

From an Islamic standpoint, conventional capital market instruments like treasury bills, bonds, and notes are unlawful since they entail interest.

Interest (riba), is considered an unfair increase in the debt’s principal and is perceived as exploitative.

Islamic economists favor equity financing over debt because it is seen as more equitable to all stakeholders due to its risk-sharing features. Furthermore, Islamic clerics are concerned about the injustices that frequently result from excessive debt, such as the debt of developing nations, as well as the higher interest rates that are frequently imposed on people who lack collateral and the impoverished in general.

This is why Islamic capital markets are relevant as it adopts standards that are relevant to Islamic finance and specifically aim to improve and unify procedures in the Islamic financial sector with regard to accounting, auditing, governance, morality, and Shari’ah norms.

Thus, Islamic capital market tools make it possible to engage in financial activity while adhering to Islamic precepts. There are numerous options available for those who simply want to invest in and deal with Islamic capital market instruments. The major financial structures and products covered by these standards include:

• Murabaha

Murabaha, also known as cost-plus finance, is a type of Islamic financing in which both the seller and the buyer agree on the asset’s cost and markup. As a result, Murabaha is recognized as a legal type of credit sale under Islamic law even if it is not qardh ribawi.

Similar to a rent-to-own agreement, the buyer does not own the property until the loan is repaid in full.

• Salam

Similar to a forward sale contract in traditional finance, a Salam contract has postponed delivery and upfront payment.

In the event of a Salam contract, the asset delivery is postponed to a particular future date and the payment is provided in full in advance at the time of the contract.

• Ijara

Ijara denotes a contract for the hiring or rental of a good or commodity in order to benefit from its usufruct.

Conventional leasing contracts are replaced with ijarah which grants individuals the luxury of acquiring the right to utilize an asset without acquiring ownership.

• Istisna

An Istisna is often a long-term contract under which one party agrees to manufacture, develop, or construct assets with the other party’s commitment to providing the finished product to the client.

In contrast to the salam contract, which requires full upfront payment, istisna provides individuals with flexibility by enabling payments to be made upon delivery, after the project is complete, or in installments.

• Mudaraba

A Mudaraba is a partnership agreement in which the Shahib al-maal (provider of capital) gives the Mudarib (provider of skill and labor) funds in exchange for the mudarib using his labor and initiative to invest it in a business. Both parties split the profits in accordance with the agreed-upon ratio, and any losses are paid for by Shahib al-maal unless they result from misbehavior, negligence, or a violation of the terms by the Mudarib.

FINAL THOUGHTS

Islamic finance fundamentally differs from traditional interest-based and speculative methods because it only makes use of genuine economic transactions like trade, investments based on profit-sharing, and other cooperative business models.

Over the years, Islamic methods of product structuring, project financing, stockbroking, asset management, and venture capital services are becoming more broadly accessible, and the Islamic capital market has become more sophisticated.

The adoption of sharia-compliant stocks and asset-based transactions in the Islamic economy ensures that Islamic capital markets play a crucial role in meeting the needs of investors who want to diversify their investment portfolios.