Islamic Capital Markets
Islamic peculiarity of capital markets results in proper financial functioning and its stable development. According to the specifics of Islamic culture, finances of appropriate countries differ from conventional capital markets. The Islamic capital market belongs to the financial system that does not use interest charges. However, the principles of Islamic finances are much wider than the rejection of interest rates. They are based on Shariah, as a set of rules and regulations, relating to economic management, social, political, and cultural aspects of Islamic society. However, the Islamic capital market differs from the traditional type by functional details and interest, but has similar composition and development.
Differences between Islamic the Conventional Capital Markets
Islamic capital markets arrange capital transactions, performed in compliance with Muslim religion. Fill adherence of finances and capital markets to Islamic laws means that they relate to the activities that are not prohibited by Muslim principles. In contrast to conventional type, Islamic capital markets are tightly connected with religion and appropriate behavior of financial participates. In the mid-twentieth century, Islamic financial institutions in the Eastern countries started using the principles that do not contradict with the religious teachings of Islam. Subsequently, the world obtained a new concept - Islamic finance, which includes Islamic banks, Islamic insurance companies, foundations, and the resulting products. The activity of Islamic capital markets is carried out in compliance with Sharia, as a set of laws, which formulated the fundamental principles and prohibitions of Islamic financial activities.
In contrast to conventional capital markets, the principles of the Shariah markets include the following rules:
- money cannot and should not be arisen out of money, i.e. capital gains cannot occur in the sphere of money circulation;
- investors’ income should be associated with investments in production and trade;
- the relationship between parties of any capital transaction must be based on partnership;
- money is not a commodity - it is only a measure of value.
In contrast to Islamic capital markets, conventional type of capital transactions is based on the benefits of speculation, better options during a trade of currency or bonds, verification of personal advance, strong demand for interest, earned money on utilization of other forms of money. Islamic principles are strongly recommended to follow by all Islamic banks and capital markets. Therefore, they are popular and trustworthy to foreign corporate investors who intend to reduce their costs and concerns, while performing any kinds of financial transactions.
Along with these special Islamic principles of capital markets’ functioning, Muslims provide the prohibitions for this type of economic relationships. They are the mixture of economic, financial, and religion norms, regulated by the activity of the parties in the capital markets:
- riba (any loan interest): prohibited interest-bearing borrowings (loans), bonds, deposits, fixed income;
- gharar (speculation, excessive uncertainty about the subject of the contract and its essential terms): derivatives (forwards, futures, swaps, etc.), traditional insurance;
- maysir (unjust enrichment, gains arising from a random set of circumstances): gambling, betting transactions, traditional insurance (Dusuki, 2009).
Unlike conventional capital markets, Islamic type of these markets do not accept any interest from marketing performance and exclude a number of financial tools that are widely used by American, European, and other capital markets.
During the period of its existence, Islamic capital markets have successfully developed from a concept into full-fledged financial institutions, so the market stays attracted for the international financial community. One of the most popular and developing tools of Islamic capital markets and Islamic financial markets is a sukuk (Dusuki, 2010). Organization of accounting and auditing of Islamic financial institutions is one of the leading organizations that develops standard activities of Islamic capital markets, defines sukuk certificates as equal to the nominal value of certifying undivided ownership interest in tangible assets, rendered services, or the assets of a specific investment project (Dusuki, 2010).
Despite the fact that investors often perceive sukuk as Islamic bonds, there is a fundamental difference between these instruments. The main difference lies in the fact that the bond is a duty, while the sukuk is the share in allocated tangible assets or in the financed project. Yield, unlike bonds, is formed by profits from the use of dedicated assets, services, or activities financed by the project. Before the emergence of sukuk, Islamic financial product line could not provide a product, able to be traded in the secondary market. Sukuk is an ideal tool from the perspectives of Islamic investors, as it is a stake in the real assets. Moreover, it is traded in the secondary market, not being a direct duty. In addition, the issuers of sukuk may be Islamic capital markets, sovereign issuers, and companies whose activities are not contrary to Shariah. Conventional capital markets do not provide this financial value, as it appeals to speculative advance and direct duty. Traditional capital market is a benefit-oriented business, functioned on the basis of profitability due to the payment of parties for performance. Moreover, Islamic capital markets are not intended to cheat the opposite party to obtain benefits, unlike conventional capital market that fluctuates due to influence of numerous participants on the welfare and capital.
Similarities between Islamic Conventional Capital Markets
It is well known that conventional trade of derivatives within the Islamic financial system and capital markets is very problematic, since the use of such derivatives in Islamic banking can lead to increased uncertainty (gharar), debt trade, and speculative behavior (maysir). However, this does not mean that Islamic instruments that have characteristics of derivatives are prohibited. In fact, there are Islamic financial derivatives, like traditional derivative instruments, which may also be the basis for the formation of derivatives, complying with the requirements of Shariah.
Individuals involved in demand deposits and similar deposits in conventional banks face the same risks and require the same degree of protection. While the bankruptcy of certain corporation usually causes no dissemination of harmful effects on the entire economy, the bankruptcy of an individual bank may undermine the trust of population to the banking system, including Islamic. Supervision of conventional and Islamic banks are equally obliged to provide customers of Islamic banks with the same level of protection, as the customers of traditional banks in the capital market. Almost every Islamic financial instrument has a traditional analog. Its implementation is more simple and less related to transaction costs. In this case, the serious question of appropriateness of the emergence of Islamic financial institutions in the traditional financial systems arises (Yusof & AbdulMajid, 2007).
Assigned ratings are recommended for both sukuk and traditional Eurobonds for more investment attractiveness. Alost half of the issued sukuk are the ratings from leading rating agencies. Malaysia makes great contribution to the ratings’ assignment (Abdullah, Hassan, & Mohamad, 2007). This country takes leading positions by the number of issues and volumes. Moreover, the assignment of rating is mandatory in Malaysia. In addition, the country combines the traditional and Islamic capital markets and operates conventional and Islamic financial systems.
Conventional and Islamic capital markets experience use of exchange bills and other papers dealing with commerce. These financial instruments played the significant role in liquidity management to finance a debt. Importing and exporting operations may be financed by exchange bill. As it is accepted, a bill belongs to security, related to market relationships. Its market value is determined by maturity and the rate of interest. The only difference is that Islamic participants of capital markets are not allowed to use the interest rate. However, both capital markets and financial systems have similar procedures of bill’ exploitation, despite the differences in transactions’ principles and the bill value.
Both traditional and Islamic capital markets function due to particular similar financial instruments. They can be divided into equity and debt instruments. Equity instruments exist in the form of share certificates of ordinary or privileged shares. Debt instruments consist of bonds that can be divided into ordinary bonds and convertible bonds (Ashhari, 2009). The main difference between stocks and bonds is the payment of income (or in the form of dividends or interest) to the owner or the owner. These tools are used in the conventional and Islamic capital markets, but their exploitation differs, according to principles of competition in conventional markets and Shariah-oriented Islamic markets of capital.
Islamic and conventional markets of capital are similar in the composition of participants. Thus, capital markets of Islamic countries and conventional capital markets are supported by private, government, and quasigovernment structures that carried out financial transactions. Both markets are used for emission and trade of long-term financial instruments. However, conventional markets are expanded due to short-term instruments.
To sum up, Islamic capital market functioning is characterized by Sharia compliance, prohibited the emission and trade of financial instruments that are widely used in conventional capital markets. However, common principles of organization and composition of capital markets are similar. Conventional and Islamic capital markets functions due to the same form of obligations and bonds. Both markets are supported and promoted by similar market actors. Common features of composition and development are similar, while functional principles and advance differ from Islamic conventional capital market.