UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for December 21, 2010

Risk Mitigation Through ‘Urbun’ In Islamic Finance or the Down-Payment Scheme

 

 

‘Urbun’ in Islamic Finance is a down-payment paid by the buyer to the seller giving the right (option) to the buyer to settle the remaining outstanding payment within a prescribed period of time.  The investor can choose not to pay the remaining amount in the prescribed period of time, however, the ‘urbun’ or down-payment is then forfeited.  However, the forfeited down-payment may be less than the decrease in the price of the investment and therefore the ‘urbun’ has the effect of mitigating the loss incurred by the investor in investments.  ‘Urbun’ is accepted in many Sharia’h standards of Murabahah, Ijarah, and Istisna. 

For example, Without ‘Urbun’, an investor in stocks/commodities must pay the full payment price or must have agreed to pay a certain fixed price to the seller to obtain the ownership rights to the stocks/commodities.  If the market price decreases, the investor’s loss is proportionate to the market price decrease. 

Illustration:  

An Investor in a fund purchases a basket of  shares at USD 1,000,000.00 in anticipation that the value of the shares would increase in the future.  Without ‘urbun’, if the value of the shares decreases to USD 900,000.00, the Investor in the fund will incur a loss of USD 100,000.00. 

However, if Urbun is used, the Investor in the fund can limit the exposure of her loss.  In order to obtain the right to purchase these shares with the value of USD 1,000,000.00, the Investor in the Fund only needs to pay, for example, USD 20,000.00 up front as a down-payment and the remaining USD 980,000.00 within for example one month or the prescribed time period.  Suppose the value of the shares goes up to USD 1,100,000.00 in one month.  The Investor may exercise the right to obtain the shares by paying the agreed upon  amount of USD 980,000.00 within the prescribed period of time and then sell the shares at the market rate of USD 1,100,000.00,  thereby making a profit of USD 100,000.00. 

On the flip side, if the market value of the shares goes down after the Investor has made the USD 20,000.00 down-payment, the Investor may choose to not exercise her right to purchase the basket of shares for USD 1,000,000.00 and incur a loss of USD 100,000.00.  If the Investor backs out, the Investor then forfeits her USD 20,000.00 down-payment, however, the loss the investor incurs at USD 20,000.00 is less than the decrease in the market price of the basket of shares which was USD 100,000.00.  Therefore, through ‘urbun’, the investor has limited the scope of her loss in the investment while preserving her ability to make a profit from the investment scheme.  This is a brilliant risk mitigation concept!  (AMANIE)

Sharia’h Parameters of Islamic Derivatives

http://www.kantakji.com/fiqh/Files/Finance/N362.pdf

Sharia’h Compliant Swaps and Hedging to Mitigate Risks

www.assaif.org/content/download/…/D1-1615-Mian%20M%20Nazir.pdf

Management of Risk by State Bank of Pakistan

http://www.docstoc.com/docs/34755772/Risk-Management-in-Islamic-Banking-by—State-Bank-of-Pakistan

Parallel drawn by Adam Lewis of Melbourne, Australia that this is the same or similar to  a call option in conventional western finance.

http://en.wikipedia.org/wiki/Call_option

Introduction to Risk Management in Islamic Finance

 

 

Islamic finance is essentially an asset-based transaction. (AMANIE)  ‘The concept is more accurately that money has no intrinsic value – it is only a measure of value, and since money has no value itself, there should be no charge for its use. Therefore, Islamic Finance is said to be asset based as opposed to currency based whereby an investment is structured on exchange or ownership of assets and money is simply the payment mechanism to effect the transaction’  (http://www.grapeshisha.com/information/a-basic-guide-to-Islamic-finance.html)

‘The profit, payoff, and loss to the parties are linked to the credit, market, and investment return risk.  The most basic form of risk management in Islamic Finance is the undertaking by the lessee in Ijarah Muntahiya bi Tamleek to purchase the leased asset upon the failure to pay the scheduled rental payments.  This is based on the Wa’d principle (risk management tool).  http://www.kantakji.com/fiqh/Files/Finance/N418.pdf

Wa’d is an undertaking or promise given by the promisor in favor of the promisee.  The Wa’d binds the promisor such as if the promisor were to breach the undertaking, she is to compensate the promisee for the actual damages arising from the breach of the promise.  (Amanie)

The market and investment return risk is relevant to Islamic –based investment in commodities, Sukuk, and equities.  When executed in different currencies, then the currency risk is also relevant.’  (AMANIE)

 

Innovation and Risk Management in Islamic Finance: Sharia’h Considerations

http://monzer.kahf.com/papers/english/INNOVATION_AND_RISK_MANAGEMENT_IN_ISLAMIC_FINANCE_SHARIAH_CONSIDERATIONS_harvard_APRIL_06.pdf

Risk Management of Islamic Finance Instruments

http://www.qfinance.com/contentFiles/QF01/g4fqn4jz/10/0/risk-management-of-islamic-finance-instruments.pdf

Downloadable Books and Articles on Islamic Finance by Maulana Justice Taqi Usmani

 

Maulana Justice Taqi Usmani

http://en.wikipedia.org/wiki/Muhammad_Taqi_Usmani (Wikipedia Explanation of Author)

Islamic Finance by Maulana Justice Taqi Usmani is available now for download in .zip format. Book covers the following aspects of financial operations:

  • Musharakah;
  • Mudarabah;
  • Combination of Musharakah and Mudarabah;
  • Some objection on Musharakah Financing;
  • Diminishing Musharakah;
  • Murabahah;
  • Some Issues involved in Murabahah;
  • Ijarah;
  • Salam and Istina;
  • Principles of Shari’ah, Governing Islamic Investment Funds;
  • The principle of Limited Liability.

(download the book: “Islamic_finance.zip“, 158Kb)

From the Website: http://instituteofhalalinvesting.org/

Or from the Site http://attahawi.com/2010/01/26/an-introduction-to-islamic-finance-by-mufti-muhammad-taqi-usmani/

Introduction to Islamic Finance  http://attahawi.files.wordpress.com/2010/01/an-introduction-to-islamic-finance.pdf

Download More Books:

http://www.ebookf.com/ta/taqi-usmani-book.pdf

http://top-pdf.com/download-mufti-taqi-usmani-books.html

Articles:

The Disposal of Interest Money http://www.fatwa.org.za/Islamic%20Banking/interest/disposal%20of%20interest2.pdf

Hajj  http://www.central-mosque.com/fiqh/hajj.pdf

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance