A Beginner’s Guide to Islamic Finance

Islamic finance is based on Islamic or Shariah rules and principles and differs from conventional finance. Even though Islamic finance has similar features and products to conventional finance, all methods of financing and transaction, including personal financing, savings accounts and investments, must follow these few but very specific rules:

• No interest (riba) can be charged or earned across all Islamic finance products and services.

• Free from any prohibited elements in Muamalat (Islamic transactions) such as usury, gambling, uncertainty, cheating and fraud.

• All transactions and contracts must be transparent, just and fair for all customers. This includes the clear disclosure of all charges imposed, as well as no hidden or excessive fees.

• The prohibition of investing in non-Shariah compliant activities such as conventional banking, gambling, liquor-related activities, non-halal food and so on.

Unlike most financial institutions, the primary purpose of Islamic finance is not to focus solely on generating profit. Instead, Islamic finance is seen as a risk sharing service that works with the community to provide Shariah-compliant products and services across various financial-related matters.

Islamic financial institutions will still need an income to operate and provide its services, and they do this through their product offerings such as cost-plus profit contract, profit-sharing contract, investments and leasing. Islamic financial institutions do not view its customers solely as clients but as partners as well. This is emulated via the Musyarakah contract (partnership contract) where Islamic financial institutions and their clients/partners contribute jointly to the capital of a specific project. Profits and risk of losses are shared between these two parties according to the terms and conditions stipulated in the contract.

It is this methodology that causes academics to believe that had the global marketplace been regulated by the rules of Islamic finance, many financial crises could have easily been averted.

History of modern Islamic finance and development of takaful in Malaysia
The history of Islamic finance can be traced back to the 2^nd century with trade occurring along the silk route between China and Europe^[i]. Modern Islamic finance, however, has its roots in 1960s Egypt via an undercover experiment in the town of Mit Ghamr.

In 1975, Dubai Islamic Bank was established as the first Islamic bank, and it was only two decades later, in 1997, when the first traditional bank began to offer financial products in accordance with Shariah law.

Malaysia began its foray into Islamic banking with the enactment of the Islamic Banking Act of 1983. Since then, we have grown to become one of the key players in the global Islamic finance market.

Following that, the Takaful Act was enacted in 1984 due to a decree issued by the Malaysian National Fatwa Council announcing the invalidity of life insurance contracts as they were not Shariah-compliant. The country’s first takaful operator was incorporated in November of that same year.

Like Islamic finance, takaful is one of the fastest growing service industries in Malaysia. Backed by the Malaysian Government’s commitment to uphold takaful and promoting an Islamic legal system to govern Shariah-compliant transactions, the demand for takaful continues to grow and Malaysia is now home to fifteen takaful operators^[ii], including Prudential BSN Takaful Berhad (PruBSN).

Participating in a takaful contract
Takaful was formulated as an alternative to insurance when many Muslim scholars declared insurance contracts as haram due to them containing potentially haram elements such as riba (interest or usury), gharar (uncertainty), and maysir (gambling).

The fundamental difference between takaful and insurance is rooted in the type of Shariah-contracts adopted from Islamic finance:

• Ta`awun and Tabarru`
  Ta`awun is an underlying Shariah principle of mutual assistance among participants of a specific takaful contract. This means that all participants mutually agree to participate in a takaful contract together with all the other participants. This is typically done by tabarru`, a charitable portion allocated from a participant’s regular contribution that will be pooled into a tabarru` This fund will then go towards providing mutual financial benefits payable to all eligible participants or their beneficiaries upon the occurrence of pre-agreed events, such as critical illnesses or death.
  

• Wakalah
  Wakalah is an agreement between a participant and a takaful operator appointing them to manage the overall services provided under their certificate. Takaful operators will deduct a fixed wakalah fee in return for their service.

• Mudarabah
  Mudarabah refers to an agreement appointing a takaful operator as a mudarib (manager) to invest a participant’s fund. Any profit generated is shared between the participants and takaful operator according to a mutually agreed profit-sharing ratio. However, as all investments incur risk, a return of principal as well as investment profits are not guaranteed.

• Hibah
  Hibah is a transfer of ownership of an asset from a donor to a recipient without any consideration. To find out more about hibah, read our articles ‘The Importance of Naming a Nominee for Your Takaful Certificates’ and ‘PruBSN WarisanPlus: The Best Hibah Plan for Your Family’.
  
  

As with all types of financing, be it Islamic or otherwise, always put your money towards a registered legal financial and takaful institution. With its clear-cut rules and a strong regulatory framework, the marketplace for global Islamic finance and takaful is only expected to strengthen.

PruBSN specialises in providing takaful solutions to help you get the most out of life. Prepare your legacy for your loved ones with PruBSN WarisanPlus, grow your savings with PruBSN Aspirasi, or set up your medical emergency fund with PruBSN AnugerahPlus. Additionally, we have a number of Shariah-compliant funds you can invest in to help you plan and achieve your desired financial goals.

To find out more about our takaful products and solutions, please contact our Takaful Agents today.

^{[i] “The History of Islamic Finance” by SarayCon, 30 December 2018, The History of Islamic Finance | Saraycon}

^{[ii] “Insurance Companies & Takaful Operators” by Bank Negara Malaysia, based on updated list as of March 2021, https://www.bnm.gov.my/takaful-operators}