PLEASE ANSWER THE FOLLOWING QUESTION AFTER READING THE PARAGRAPH: How might religion impact financing operations?

The Impact of Religion: Islamic Finance

As we learned in Chapter 8, Section 2 Understanding International Capital Markets Fundamentals, companies operating in countries where Islam is the official religion, such as Malaysia, Saudi Arabia, Kuwait, Bahrain, and the UAE, must adhere to Islamic finance laws. Islamic law prohibits certain financial practices that are common in other countries. For example, Islamic law (called Sharia) prohibits charging interest on money. No interest can be charged, including fixed-rate, floating, simple, or compounded interest, at whatever rate. The Sharia also prohibits financial practices like speculation, conventional insurance, and derivatives, because theyre considered gambling in the Islamic tradition. Sharia also prohibits gharar, which means uncertainty and includes conventional practices like short selling.

To overcome these prohibitions, financial products must be Sharia compliant. There are approved alternatives to interest and speculative investments. For example, instead of lending money and charging interest, banks can lend money and earn profits by charging rentals on the asset leased to the customer. One alternative investment strategy, musharakah, allows profit and loss sharing. Its a partnership wherein profits are shared per an agreed-on ratio and losses are shared in proportion to the capital or investment of each partner. A mudarabah is an investment partnership, whereby the investor provides capital to another party or entrepreneur in order to undertake a business or investment activity. While profits are shared on an agreed-on ratio, loss of investment is born only by the investor. The entrepreneurs only lose their share of the expected income.

These investment arrangements demonstrate the Sharias risk-sharing philosophythe lender must share in the borrowers risk. Since fixed, predetermined interest rates guarantee a return to the lender and fall disproportionately on the borrower, they are seen as exploitative, socially unproductive, and economically wasteful. The preferred mode of financing is profit and loss sharing.

Islamic finance as an industry is still evolving, developing, and growing. The industry has also grown from retail banking to commercial banking and, more recently, into investment banking. Its sophistication and product offering have developed along with this change. Islamic financial institutions have taken the form of commercial banks, investment banks, investment and finance companies, insurance companies, and financial service companies. A growing number of conventional financial institutions, both inside and outside the Islamic world, have in recent years created Islamic subsidiaries or have been offering Islamic windows or products in addition to conventional ones.