The Theory and Practice of Profit Sharing Investment
Foundations of Islamic Finance series
Edited by Mohamed Ariff, Munawar Iqbal and Shamsher Mohamad
Chapter 4: A Guide to Islamic Finance Principles and Financial Engineering
Munawar Iqbal 4.1 INTRODUCTION Despite commendable progress in product development, there are many areas of financial transactions where suitable alternatives for modern conventional products have yet to be developed. Product development is one of the biggest challenges facing the Islamic Finance Industry (IFI). In the Islamic theory of contracts of exchange, the general rule is that of permission. Every contractual arrangement is permissible unless expressly prohibited by shari’ah, and the prohibitions are surprisingly very few. Until now, Islamic financial products have essentially been based on classical modes developed centuries ago. While they may serve as useful guidelines, they may not serve the needs of modern financial markets which are becoming more and more sophisticated and competitive. In order to exploit the fast-changing market environment and to face increasing competition, financial engineering innovation is imperative. While it is possible to modify classical contracts to suit modern conditions, a much broader scope for financial engineering exists in developing new contracts. However, because of the requirement that every new product be compatible with shari’ah, anyone wishing to enter this arena needs to know the basic principles of the Islamic theory of contracts and the do’s and don’ts of shariah. Explaining these is the purpose of this chapter. Financial engineering means different things to different people. One of the meanings, which is the most relevant to this discussion, is ‘it is the process of design, development and implementation of new innovative financial products, processes and the formulation of creative solutions to problems in finance’....
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