Abstract
Financial intermediation is the core of the banking business, as its role is to mediate between the owners of surplus funds and those in need of finance, sharing the generated profit with the funds' owners. However, financial intermediation does involve some economic risks in terms of concentration of debt in financial institutions and the possibility of the inability of financed clients to repay their debts. When this happens, financial crises are inevitable, as it occurred in 2008. Islamic finance does not differ in this regard from its traditional counterparts, because the concentration of debts also holds on the concept of Islamic institutional finance, and the possibility of collective default is possible as well. The study treats the issue of financial intermediation and its risks from Maqasidi aspect using home finance as a point of comparison between conventional home finance with Islamic home finance in terms of their economic effects. The study eventually proposes a model for home financing that is free of these cautions.
TopIntroduction
Regardless of its particular identity, banking is essentially performed on two levels: the first level is mediation between the owners and users of funds, i.e. depositors and investors (borrowers in conventional terms). The second level is between buyers (borrowers) and sellers, with the bank paying the price to sellers on behalf of buyers. The bank achieves this latter mediation through the former mediation. Hence, banking plays an important function in the present age in terms of providing a source of liquidity for individuals and institutions. It has enabled large amounts of liquidity to be available for financial intermediaries to carry out the second level of financial intermediation between buyers and sellers, by facilitating the clients’ access to expensive goods, such as homes and cars, which they can pay for in instalments over many years.
If in markets, sellers sell their goods to people directly on a deferred basis there would be no need for financial intermediation. However, the existence of financial intermediation has led to the disappearance of long-term sale contracts, especially for certain expensive items, such as homes and cars. If financial intermediaries did not exist there would be long-term sale contracts, such as for homes, but this would require large real estate companies that can afford to accept payment over several years, which is rare amongst companies.
Moreover, banks have developed a system to ensure the debts arising from their financing are reimbursed, including overseeing the transfer of their clients’ monthly salaries, establishing follow-up and collection departments that follow up with clients who are falling behind on their payments, and taking guarantees from the clients when they apply for financing. It may not be easy for real estate or car agencies to collect such guarantees.
In addition, the banks need to utilize the funds that are in their possession to generate a return from which they can earn a profit, cover their expenses, and distribute profit to depositors to attract more deposits. For this reason, banks offer to mediate between buyers and sellers, and mortgage finance became the most appropriate service to employ the vast cash reserves from deposits. From the client’s perspective, home financing meets a general need requiring large amounts of money over a long period. From the bank's perspective, mortgage finance is most suitable for banks to employ their vast finances in order to earn a stable return on their savings deposits from individuals and institutions. It is also one of the safest financing options given that the underlying property provides a guarantee and usually increases in value over time, unlike commodities, such as cars or machinery.
Hence, real estate financing has enabled many individuals to own their homes and has ensured that the banks receive stable returns in order to pay stable investment returns to their depositors. It is also an indirect way of allowing individuals to invest, because an individual may be able to pay the price of a home in cash, but prefers to buy it on finance in order to keep money and invest it in projects that earn a return and may be productive and beneficial for the economy.
Key Terms in this Chapter
Ghabn: It is an Arabic word which means “unfair advantage”. It also refers to fraud, cheating and deception.
Ijarah muntahiya bit-tamlik: It refers to an agreement whereby the bank purchases a property in cash and then leases it to the client for the financing period with the inclusion of a fee that covers the bank’s expenses and achieves the desired amount of profit. At the end of the lease, term the bank transfers ownership of the property to the client at a nominal price or at no charge.
Murabahah: A contract of sale practiced by Islamic banks, according to which the bank act as intermediary to provide finance for purchasing goods to a buyer. The bank buys the commodity on case basis then sells it to the client on credit at a markup.
Istisna’: A contract to sell a manufacturable thing with an undertaking by the seller to present it manufactured at a determined cash or credit price. The suitability of Istisna’ for financial intermediation is based on the permissibility for the contractor in Istisna’ to enter into a parallel Istisna’ contract with a subcontractor. Thus, a financial institution may undertake the construction of a facility for a deferred price and subcontract the actual construction to a specialized firm.
Musharakah mutanaqisa: It reflects the meaning of a diminishing partnership. A financier and his client participate in the joint ownership of a property. The Share in ownership of the financier is divided into parts with the understanding that the customer will gradually purchase that share via periodic payments. The objective is for the customer to become the sole owner of the property or enterprise eventually
Maqasid: Maqasid al- Shari’ah refer to higher objectives of the Shari’ah , which are looked at in separation from the particular rules of Shari’ah . The commonly known objectives of the Shari’ah include the preservation of the religion, life, lineage, intellect and property. However, for every theme of Islamic law there are some specific objectives such as removal of injustice in financial deals and protection of the contracting parties’ rights. Furthermore, every single rule in the Shari’ah has its own wisdom and objective, like removal of the causes of dispute in the prohibition of Gharar .
Gharar: is an Arabic word which means “uncertainty” in general. In contracts, it refers to lack of knowledge when something is unclear in the contract so that it may lead to dispute between the contracting parties. It also refers to gambling since one of the counter values is uncertain and the gambler is not aware of the outcome of gambling.
Riba: it refers to the interest charged on a loan contract. However, Riba may also refers to particular sales of certain commodities or currencies that have not met specific Shari’ah requirements.