How to Adopt the Principles and Practices of Islamic Finance in Modern Business Financing

Have you ever wondered what it would be like to deviate from the conventional business financing system? Do you think there exists a system free from financial monopoly, wealth usurpation, and unhealthy capitalism?

Islamic finance offers just that. Rooted in Sharia (Islamic ethical and legal principles), it presents a viable and ethical financing model that contrasts conventional systems by strictly prohibiting unfair practices such as interest (usury), gambling, speculative dealings, and engagement with morally objectionable goods and services.

While the tenets of Islamic finance have existed since the advent of Islam, their formal practice and recognition gained momentum in the 20th century with the establishment of the first Islamic banks. Its global appeal soon broadened, leading even Western financial institutions to create dedicated Islamic finance windows. Nigeria, recognizing the potential of this model, established its first full-fledged Islamic bank in 2012 . Since then, the Islamic financial industry has kept developing in Nigeria, with more banks and other Islamic Financial institutions established. Initially embraced primarily by the Muslim populace, the appeal of Islamic finance has since expanded significantly to non-Muslims due to its emphasis on ethical conduct and equitable principles.

Understanding the Foundational Principles of Islamic Finance 

To understand how these principles can be adopted in modern business financing, let's delve into the foundational tenets of Islamic finance, derived from its primary source, the Qur'an, and its secondary source, the Sunnah (practices and sayings of Prophet Muhammad).

1. Prohibition of Riba (interest/usury): Interest is totally forbidden in Islamic finance. This is because, in Islamic finance there exist no profit making in lending. A lender cannot profit from his borrower. In Islam, lending in its nature is charitable and profit can only be made through other ways like sales, trade and partnerships in business where profit and loss are shared.

2. Prohibition of Dealing in Uncertain Objects: The object of a sale have to be defined and be in existence, such that a buyer have access to inspect it before sale is made. Business is forbidden with things that are not in existence before its sale except in some cases which we will discuss subsequently. Transparency is highly important in business dealing. This principle aims to prevent deception and ensure fairness in transactions.

3. Prohibition of Maysir (Gambling): Gambling is seriously prohibited as the tenet abhors anything that will bring about unnecessary loss to one’s estate. Any speculative activities that involve unnecessary risk and the potential for unearned gains or losses are strictly forbidden. Islamic finance encourages transactions based on real economic activity and discourages those akin to games of chance.

4. Halal (Ethical ) Investment: Islamic finance, in its ethical nature, ruled against dealing with certain products which include alcohol, pork, carcass, tobacco, and anything that brings harm to mankind.

5. Profit and Loss Sharing: Partnership in businesses must be with the prior agreement of risk sharing. Islamic finance rejects the concept of one party unilaterally bearing losses or solely benefiting from profits. To facilitate this, Islamic finance has developed various contractual structures, including Musharakah, Mudharabah, Ijara, and Salam, which embody this principle of balanced risk and reward.

Key Ways Modern Businesses Can Adopt Islamic Finance in Financing Their Business

1. Musharakah (Equity Financing): This is a kind of joint venture in business where two or more parties finance the capital of a business. All parties, some or one of them, can manage the business. Profit sharing in this venture must be agreed in ratio and not in money worth, while losses are shared in proportion to the capital contribution of each partner.  

2. Mudharaba (Business Financing): In this kind of partnership, one party finances the business while the other manages it utilizing their expertise. In this, too, profits are shared according to a pre-agreed ratio, while losses are borne solely by the capital provider. The manager (Mudarib) can only suffer a waste of time and energy, except in cases of Mudarib's negligence or misconduct, where he will be liable. 

3. Murabahah (cost-plus sale): This mode of finance is commonly utilized by Nigerian Islamic banks. It involves a sale where a party agrees to purchase an item requested by an obligor, with the latter having knowledge of the cost and profit of the purchased item. Simply put, the financier reveal the purchase cost and the profit cost on the item. Here the obligor has the liberty to pay on point or at a later date as agreed by both parties. 

4. Ijara (Lease): This is a Sharia-compliant leasing agreement. Instead of taking out an interest-based loan to purchase an asset, a business can lease the asset from an Islamic financial institution. The institution owns the asset and leases it to the business for a specific period at an agreed-upon rental. Ownership of the asset remains with the lessor. Ijara can be used for financing equipment, vehicles, and property.   

5. Salam (Project Financing): This contract for a forward sale with deferred delivery. A buyer pays in advance for specific goods to be delivered at a future date. This is particularly useful for financing agricultural production or manufacturing, where there is a time lag between payment and delivery of the finished product. It provides the seller with upfront capital while guaranteeing a future supply for the buyer.

6. Istisna (Manufacturing Financing): This is a sale concerning future goods. In this case, the buyer pays in advance for goods that do not yet exist, covering part or all of the manufacturing costs, which helps finance the manufacturer for the goods to be delivered at a later date. Additionally, this arrangement provides the seller with sufficient capital to acquire raw materials needed for producing the products. Although Salam and Istisna’ are similar in that they both involve non-existing goods, they differ in terms of their transaction methods. Salam typically pertains to agricultural products, while Istisna focuses on manufactured goods. For a Salam transaction to be valid, the buyer must pay the seller in full upfront, specifying the quantity and quality of the product. Conversely, Istisna permits installment payments. Furthermore, Salam mandates a fixed delivery date, while Istisna does not necessarily require one. 

7. Sukuk (Islamic Bonds): For larger businesses seeking to raise capital, Sukuk offer a Sharia-compliant alternative to conventional bonds. Sukuk are asset-backed securities that represent ownership in a tangible asset or a pool of assets. Returns are generated from the underlying asset's profits or rental income, rather than fixed interest payments. Various types of Sukuk exist, catering to different financing needs. For example, an organization seeking to maintain or increase its liquidity can subscribe to the Musharakah Sukuk when issued.

8. Takaful (Islamic Insurance): While not a direct business financing, Takaful provides a Sharia-compliant alternative to conventional insurance. Participants contribute to a pool, and in case of loss, claims are paid out of this pool based on the principles of mutual assistance and shared responsibility, avoiding the element of speculation inherent in conventional insurance.    

9. Islamic Finance Technology: Islamic Fintech integrates Islamic finance principles with technological innovations. By leveraging technology, Islamic finance drivers offer solutions in production, services, and sales through platforms like e-banking, blockchain, and digital payments in compliance with the Islamic principles, enhancing efficiency and accessibility. 

Benefits of Adopting Islamic Finance for Modern Business.

1. Risk Sharing: Unlike conventional debt financing, where one party bears the entire risk in some partnership, Islamic finance, particularly through principles like Musharakah and Mudharabah, promotes risk sharing between the financier and the business. This can be especially beneficial for startups and businesses facing uncertainty. 

2. Usury-Free: Adherence to the prohibition of Riba (interest) offers businesses a financing model that is ethically sound, wealth-sustaining, and potentially more stable in the long run, as it discourages debt-driven growth and excessive leveraging. 

3. Alternative Funding Avenues: Islamic finance provides businesses with access to a diverse range of funding instruments beyond traditional loans, such as equity partnerships, leasing, and trade financing, which can be tailored to specific business needs.

4. Ethical Investment: For businesses and investors with ethical considerations, Islamic finance ensures that funding and investments are directed towards Halal (permissible) activities, avoiding sectors like alcohol, pork, and tobacco that are harmful to human health.

5. Stability and Certainty: The emphasis on asset-backed financing and the discouragement of excessive speculation in Islamic finance can contribute to greater financial stability for individual businesses and the wider economy. 

6. Access to a Growing Market: The global market for Islamic finance is expanding rapidly. By adopting Sharia-compliant practices, businesses can tap into this growing demand from Muslim consumers and investors.

Challenges in Relation To Islamic Finance:

1. Religious-Based: While its ethical framework is a strength, the religious basis of Islamic finance can sometimes be perceived as a barrier by those unfamiliar with its principles or who do not adhere to the Islamic faith.

2. Lack of Understanding: There is still a general lack of widespread understanding of Islamic finance principles and products among businesses, legal professionals, and the general public, particularly in non-Muslim majority countries.

3. Non-Specialized Expertise: The insufficiency of professionals and advisory bodies with specialized expertise in structuring and guiding Sharia-compliant financial products and transactions can pose a challenge for businesses seeking to adopt Islamic finance.

4. Evolving Nature of Islamic Finance: The field of Islamic finance is continuously evolving, with scholars and practitioners developing new interpretations and innovative solutions. Staying abreast of these developments and ensuring compliance can be complex.

Conclusion

Utilizing the principles and practices of Islamic finance offers modern businesses a viable and ethical pathway to secure funding and manage their financial operations. By understanding the core tenets and exploring the diverse range of Sharia-compliant financial instruments available, businesses in Nigeria and beyond can tap into a growing market while adhering to principles of fairness, transparency, and ethical conduct. As the Islamic finance industry continues to evolve, businesses that embrace these principles are well-positioned for sustainable and responsible growth.

Email us at prestigeattorneys@gmail.com for guidance and expert advice on adopting Islamic finance for your businesses.