I was reading a book on Corporate Finance just now and suddenly I remembered about sukuk. However, not many of us know how it works, therefore, I decided to give a brief introduction of sukuk.
Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed income, interest bearing bonds are not permissible in Islam, hence Sukuk are securities that comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest.
Shariah requires that financing should only be raised for trading in, or construction of, specific and identifiable assets. Trading in indebtedness is prohibited and so the issuance of conventional bonds would not be Shariah compliant. Thus all Sukuk returns and cashflows will be linked to assets purchased or those generated from an asset once constructed and not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilise assets in the structure (which could be equity in a ‘tangible’ company). It’s worth noting that Equity financing is Shariah compliant and fits well with the risk/return precepts of Islam.
The Problem with Interest or Riba
As Shariah considers money to be a measuring tool for value and not an asset in itself, it requires that one should not be able to receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically interest) is Riba, and is forbidden. The implications for Islamic financial institutions is that the trading/selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissible.
The Problem of Uncertainty or Gharar
This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract and this causes issues for Islamic scholars when considering the application of derivatives. Shariah also incorporates the concept of Maslahah or Public benefit, denoting that, if something is overwhelmingly in the public good, it may yet be transacted and so hedging or mitigation of avoidable business risks, may fall into this category but there is still much discussion yet to come.
Controversy
Sukuks are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sukuk effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest.
If you are interested to know more about sukuk, you may find that the article below is very helpful and informative :
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