Conception Of Islamic Bonds (SUKUK)

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Conception of Islamic bonds (Sukuk)ABSTRACTThe substance of Islamic financial system to describe the fundamentals of sukuk a financial vehicle to mobilize finances from surplus units to shortage units in the financial ecosystem just not limited in the Pakistan financial market but of the world. The interchangeable terms of Bond and Sukuk are implicitly different in the fundamentals though, due to risk and return factor in the conventional bond. The concept of the sukuk in the Pakistan market is now at least a decade old and it has guarantee of Pakistan states bank and compliance of sharia, which makes Sukuk equally valuable as conventional bond, but has a plus point of sharia compliance. Keywords: Sukuk, Islamic finance, Sharia, Conventional bonds, AAIOFI, KiborIntroduction:Valuable market of Islamic banking in global finance industry is increasing day by day. Today there are more than 300 banks are operating worldwide successfully notably from London, Karachi, Dubai, Jakarta and Cairo. Islamic finance industry is gaining its moment from the very first day of its operations not only in Pakistan but in the world with the growth rate of 15%. Pakistan’s Islamic finance industry emerged with the historic decision of Supreme Court of Pakistan In 1999, when Supreme Court of Pakistan gave 20 years to Pakistan state bank to convert its banking system from conventional Financial and banking system to Islamic Financial system which is based on social welfare. With the growth of Islamic finance sector it was important to introduce sharia compliant financial instruments comparable to Conventional banking system’s instruments, so, the importance of financial derivatives and the definition of assets to secure these derivatives is very important. The introduction of Sukuk in Islamic finance industry was very key breakthrough in the history of Islamic finance and banking. There is also a body which regulates the instruments Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFA). Sukuk is an instrument use as Bond in the Islamic finance industry but it is different in the fundamentals. There are at least 5 types of Sukuk differentiated according to systematic specifications. First Sukuk was issued in 2000 by Malaysia. In Pakistan first Sukuk was issued by the Water and Power development Authority (WAPDA) in the year 2006. In this essay we will discuss Sukuk in details with context to Pakistan. We will discuss the fundamental difference between Bond and Sukuk. Sukuk a financial instrument in Islamic Finance Islamic law does not permits interest which is called “Riba” in Islamic Finance terms, as an alternative to ‘bond’ in conventional Finance industry , Sukuk represents the theme in the Islamic banking and finance , it is certificate that represents the ownership in the underlying real assets. It is allowed in Islamic law as it is derived from the permissible concept of Halal profit earning from buying, selling and Rental from leasing. Sukuk Holders earns from the lease or profit of real assets which is underlying in the Sukuk certificate. For instance, a general working of Ijarah Sukuk will be like this. For example a business owner requires a machinery or equipment for the expansion of business. He will issue Sukuk that can be purchased by any eligible individual or institution. He will buy that equipment from the sale of Sukuk. During the period of lease, business owner will pay the rent / lease to the Sukuk holders that will generate the income stream for the Sukuk holders. Sukuk holder will redeem their investment after the completion of said time. Business owner will purchase the asset (Machinery or equipment) in separate contract that will help him redeem the investment of sukuk holders. Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)With the emergence of Islamic banking and finance industry it was the need of time to establish a regulatory body for this industry, so, to fulfill the need AAOIFI was established in year 1991, it is based in Bahrin. It is leading organization for the development and regulation of Islamic finance industry. It has issued more than 100 sharia compliant standards in the area of Islamic banking, financial ethics, auditing and governance. Islamic financial institutes around the world follow that standards issued by this organization. Difference in sukuk and BondIn short we can say Sukuk is an Islamic law compliant Riba free Bond, because bond are securities and their Riba (interest rate) is comparatively high, with fluctuation in returns so in general Bond are used as Fixed interest returns. There are five major differences in the Sharia compliant Sukuk and conventional bond these differences are as following;Conventional bonds are indication of debt obligation, while Sukuk is an indication of ownership (Any tangible asset). We can only issue sukuk for the assets which are sharia compliant, but we cannot guarantee the assets (Product, service) behind the Bond. Credit rating is what defines the price of conventional bond, but sukuk are priced according to the worth of underlying asset.The increase in the value of sukuk is Halal, because there is actual asset behind the sukuk, and the increase in worth of sukuk is actually increase in the worth of asset, but conventional bond gives fixed interest which is Riba. When we sell Sukuk we are actually selling the ownership of the underlying asset but in case of conventional bond the sale of bond is mere indication of debt collection for a purpose. Firstly, Sukuk are backed by tangible assets that are why their ownership is an indication of ownership of worthy assets whose value may increase in the future that will result in the value increase of Sukuk. And the worth of the asset is key factor to define how many Sukuk should be issued at what price. But the Bond ownership is the ownership of legal certificate: which is to be used to raise money. In the case of bond; bond holder act as a lessee. The value of the bond will increase or decrease according to the Rate of return of the bond and current rate of return of the market which act inversely proportion. In sukuk, the purchaser is purchasing an asset that has value rather than participating in an implicit loan agreement. Secondly the one of the most important and technical point in Sukuk and conventional bond is the underlying asset, In case of Sukuk, the underlying asset must be Sharia compliant (should be providing Halal services or producing Halal products). In case of conventional bond there is no obligation to use Sharia compliant asset, product, service or bundle of sharia compliant and non compliant services or products. The Sukuk holder always has assurance of Sharia compliancy. Thirdly, the difference between the interchangeable terms Sukuk and bonds is not just mere technical difference. These differences one way or other develop the Islamic financial system which is Riba free and completely based on the social welfare of the society, that’s the main reason Riba is described as “Zulm” in Islamic banking and finance. Just not this, Interest based loans and transactions have caused enormous difficulties in the system and higher inflation rate in the economies. That is why one of the most important reason Sukuk bonds are priced according to the worth of underlying asset that tangible asset is a real thing behind Sukuk but in case of Bond, they are priced according to the credit rating of the bond, and credit ratings can be forged, This is necessary in the case of bonds because when you sell a bond on the secondary market, you are actually selling the debt in the underlying loan relationship. The sale of a sukuk on the secondary market is simply the sale of ownership in the asset.Fourthly, the advantageous difference of Sukuk over Bond is the concept of price appreciation is simple and clear. Every sukuk is backed by the Asset and the price of asset is what defi

 

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