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Guaranteed Financial Independence with 7 Power Habits

The best course of action to take sometimes isn’t clear until you’ve listed and considered your alternatives. The following paragraphs should definitely help clue you in to what the experts think is significant.

Are you always running short of your funds? Do you still have to borrow money sometimes to at least live comfortably? Do you get to pay your bills on time?

If you answered mostly yes, then you are in danger of being financially unstable. You cannot afford the things you want and sometimes, even the things you need. Don’t go sulking out there! You better move your body. If such is the case, better tell yourself that you cannot afford to be that way always. You have to be financially independent.

What is financial independence? Financial independence is the capability to determine and support yourself through your own endeavors. There are 7 ways or habits for you to follow to gain financial independence. With the right attitude and the proper goal in mind, you might just find yourself beaming with pride because of your achievement.

1. Keep a focused vision

Start with a vision. What is your vision for your life? Where are you definitely heading? You want financial independence. You want to be able to stand on your own and have a more stable and secured life, for yourself and for your family.

Keep that vision in mind. Hold on to it as you start to realize that vision. The choices and decisions you will make in the future will have to head to the direction of your goal. Return to that vision when things get doubtful or tough.

2. Invest your money wisely

Generate income. Your income will be the financial foundation of your vision. This will basically come from your job’s income, but don’t settle with that.

Aim to increase your income. Invest your time, money and effort into a beneficial enterprise. Start a business that you feel passionately about and make sure it will work. Think carefully of every detail in your enterprise and work on it. Do not settle with good enough results. Aim for excellence, quality and integrity to succeed.

3. Save up

Start a fund for your future. Allot a percentage of your present income to savings. Do this at the start of each month, before you go ahead. This will avoid the enticement to buy, buy, buy. It will also teach you how to properly budget your money for necessary expenses.

Money in the bank could also earn interest. Although it is not considerable compared to a good investment, it is still a good way to keep money for your future. Just make sure you maintain the money in your savings account. Avoid touching it unless it is really necessary.

Most of this information comes straight from the financial independence pros. Careful reading to the end virtually guarantees that you’ll know what they know.

Give value also to your coins. Every single cent matters. All of those scattered coins you have there could comprise a few dollars. Even if it is considerably small amount, it will still find some use for that.

4. Spend wisely

Don’t spend all your earnings. As they say, don’t earn to spend. Buy only things that you really need. Tighten those belts for now as you bank for a more secured future. Choose to live simply. Forget the need to show off on other people that you can afford. If you want achieve financial independence, you must hold on to your money as much as possible.

Avoid incurring debts as much as possible. Take control of your finances as much as possible. Credit cards for example could hold you locked in a desperate state. You could be getting what you want now through that credit card, but imagine yourself giving the bulk of your income for interest payments! Make ends meet in the meantime for later on in life, you will surely afford to be leisurely.

5. Keep contingency plans

You must plan ahead for events in the future. Have contingencies. Make certain that your financial assets are secured. At this phase, it is a good option to get an insurance policy. Insure your life, health and property, even your loved ones.

Protect your interests whenever you enter into any engagement. Make sure that your endeavor is legal, that you are financially capable, and that it is feasible within your means. This way, you will have optimal performance and desirable results. You could prevent harmful losses in the long run.

6. Take care of yourself

Health is wealth. The only way for you to achieve your dreams and be able to stand on your own is when you are physically and psychologically able to do so. Have regular check ups with your physician. Have a healthy diet. Exercise Regularly. Health will be your asset to achieve financial independence. Only a good physical standing would allow you to enjoy the fruits of your toils today.

7. Be Unstoppable

You must keep yourself focused to achieve the goal of being financially independent. Do not let yourself be distracted by whimsical desires. Do not spray. Do not procrastinate. Every cent and every minute counts as what you do today will have a lot to say on what you will have in the future. Take advantage of every opportunity that will come your way. Keep yourself confident.

Tell yourself, you will not be a loser in this game. You have to make it!

The day will come when you can use something you read about here to have a beneficial impact. Then you’ll be glad you took the time to learn more about powerful habits to financial independence.

Take Control Of Your Financial Freedom Today

It’s amazing how much of our adult life is spent working hard to try and get ahead. We all want to have some sense of financial control over our circumstances so we work harder to try and get ahead. We strive to build a home and to have enough financial assets to enable us to enjoy a comfortable retirement. So how can we better take control of our financial destiny today. Here are some tips to help you navigate through the financial maze and get you on track to achieve your dreams.

Don’t get scammed.
All to often its human nature to look for the short cut. The road that will give us what we want with minimal effort. Why else would there be a booming industry on how to lose weight by taking pills. However, if you fall for the get rich quick trap you are only going to put of your financial freedom through lost time, effort and money. You might even cost yourself a chance of financial freedom especially if you put your life savings into a get rich quick scheme that ends up losing your investment.

The most common scams out there are ponzi schemes, pyramid schemes and your get rich seminars. All of them are ever waiting for the next greedy sucker to part them with their hard earned money so don’t let that next victim be you. All of these schemes have one common theme and that is they offer a high rate of return for minimal effort on your part. Like the old saying goes, if it is too good to be true chances are it is.

Know what you are spending.
Get your finances in order. If you don’t know how much you are spending then how can you possibly know what expenses are necessary and what is discretionary. Imagine your fortune 500 company operating like the way you do. Spending money as they see fit without any accountability on where that money is going and whether it is a good investment or not. The company would go broke and so would you. You need to think of your financial situation the same way a multinational company does. Track and monitor your income and expenses. Question every expense and really ask yourself if it is truly necessary and whether or not it is getting you closer to financial freedom or not.

Debt is not always your friend.
Be aware that not all debt is bad and likewise not all debt is necessary good. Know the difference between good debt and bad debt. Good debt occurs when you use someone elses money to purchase or control an asset that over time appreciates in value. This includes things like property and shares. Bad debt is when you borrow money to buy things that decrease in value over time. We all know that this category includes things like borrowing for a holiday, credit cards and buying your car. If you are serious about becoming financially independent you cannot have a balance sheet that is over burdened with bad debt otherwise you are going to spend a disproportionate amount of your time, energy and money on paying of these debt and never really getting ahead financially.

Your financial freedom starts today.
Don’t think that you will get on the road to financial freedom tomorrow. Don’t kid yourself that you can live life and enjoy yourself now and start worrying about retirement later. Don’t squander today with bad financial choices, take control of your life and start investing it into getting you what you want. I mean what’s the point of enjoying your life over the next couple of years and then spending the next forty trying to stay above the poverty line because you are laden with debt. Make a decision today and take a step to either reduce your debt or start saving for your future. The decision is up to you, you are in control.

How Banking Instrument and Hard Asset Lending Programs Work

Lending programs were developed to assist clients with either financial instruments (BGs, MTNs, LOCs, CMOs, Insurance Wraps, Treasury Notes, Stock Portfolios and other financial assets) or hard assets (emeralds, rubies, diamonds, gold, silver, copper isotopes, iridium, gold dust, real estate and other assets) to free up a rather frozen, long term asset into immediate cash enabling higher return, short term investments.

The only real requirement is that the asset be assigned and lien-able securing the lenders position.

Most program loans range from fifty million (50,000,000.00) to fifty billion (50,000,000,000.00) and are for a period of one (1) year, this process is usually simple and straight forward, and best of all, quick to fund since many lenders use private funds.

First, the client usually will receive a Memorandum of Understanding (MOU) that details the lending process. If acceptable, the client provides all pertinent and necessary documentation validating ownership, authentication and value for initial review along with the signed MOU. Additional documents may be required, so please treat all lender requests with a time-is-of-the-essence urgency. Upon review of asset quality, the Loan Agreement is presented to client for review and completion. The loan review period is about three to five (3 to 5) business days with a total loan process time of about 30 days till day of funding.

Instrument General Process: If approved, usually the instrument will be purchased and held, or held and blocked, for the Lender’s benefit for the period of one (1) year. The Client has the option to “Repurchase” the instrument at its Full Fair Market Value on the day the Repurchase agreement was Fully Transacted. Upon receiving the block on the instrument, the Lender will wire transfer to the bank the loan proceeds. Depending on the quality of the instrument, the advance against the face value averages sixty to eighty percent (60 to 80%), but can be as high as eighty seven and a half percent (87.5%) for larger loans up to 50B.

Hard Asset General Process: If approved, usually the client chooses a top rated American or Western European bank that understands asset lending for their specific asset (HSBC is preferred) that is agreeable to both parties. The bank will then create a Line of Credit or SBLC for fifty percent (50%) of the assets current appraised value. The bank may require the assets to be transferred to the bank or remain in the holding depository they are currently lodged – this is solely the preference of the Client’s bank. The LC/SBLC will be drafted in the Clients name in favor of the Lender. Upon receiving the LC/SBLC, the Lender will mirror the LC/SBLC amount with a wire transfer to the bank.

The key thing to remember when presenting your asset to the bank is the inbound wire. The bank gains an asset at 50% LTV by creating a LOC triggering a mirrored inbound wire transfer with blocked funds that remain in the bank. A bankers dream come true – a no risk loan!

Since this service was created as an expeditious manner for clients to place hard assets into short term, higher yielding programs, lenders prefer the majority – if not all – of the loan proceeds go towards investments. However, they understand that a client may have an immediate capital requirement, so most allow up to 20% of the loaned amount to be dispersed to the client with 80% or more dedicated to investing.

Lender simple interest rates average from twelve and half percent to twenty percent (12.5 to 20%) depending on the asset and loan amount. The higher the loan amount, the lower the interest rate with a 50M minimum and a 50B maximum. Principle with interest is repaid in a single payment at the end of the twelve month loan period.

This lending program allows clients to obtain cash against the stagnant asset in a matter of days while they also simultaneously coordinate high yield investment programs. The loan review and trade compliance process take about 10 days for a simultaneous closing for both transactions.

Here’s a typical loan scenario: Current appraised asset value $1,000,000,000 (one billion), 50% of asset value 500,000,000, LC/SBLC created in favor of Lender 500,000,000, Lender wires to bank 500,000,000, Client is allowed up to 20% of funds 100,000,000, Cash for investment 400,000,000.

If you or a client has instruments or hard assets to lend against that that are assignable and lien-able, this type of loan program may be of assistance to you providing a bountiful returns when placed in secure, higher yielding short term programs, which are readily available.

How To Smartly Give Away Assets During Your Lifetime

Giving away your financial assets can be more complicated than just writing a check. If you want to engage in lifetime gifting of some of your assets, you should be aware of certain rules. For instance, in 2008, the maximum annual gift tax exclusion amount is $12,000 per person. The lifetime federal gift tax exclusion amount is currently $1 million, and it will remain at that level through 2009.

The top federal gift tax rate is 45% for 2008(the maximum that your heir may need to pay on your gift). In 2010, the top gift tax rate will equal the top individual income tax rate (currently 35%). Any portion of the gift tax exclusion used will reduce dollar-for-dollar your estate tax exclusion available at death. In light of all this, you may want to consider some creative lifetime gifts. For one, charitable trusts can offer you several financial benefits, including the potential deferral of capital gains taxes, as well as possible gift and estate tax savings. They may also serve as effective vehicles for transferring wealth.

A Charitable Remainder Trust is a tax-exempt way to distribute income from the trust to beneficiaries for a period of time after which remaining assets are distributed to charities of your choice. You determine the time frame of the trust—it can last a lifetime or for a fixed term of up to 20 years—as well as the amount of annual payouts. There are some requirements that you should know about. First off, the annual payout for the length of the trust or the life expectancies of the beneficiaries (which would be you or your spouse) cannot exceed 50% or be less than 5% of the value of the trust. And a private foundation or donor-advised fund may be named as the charitable remainder beneficiary.

Highly-appreciated assets owned by the trust can also be sold without an immediate capital gain, which may allow for an increase in current income as well as income tax deduction. However, the type of assets gifted and the type of charity receiving the gifts, as well as your adjusted gross income, are all taken into consideration in determining your charitable income tax deduction. What’s more, there may be income tax due on your annual payouts from the trust.

Charitable Lead Trusts are funded with assets that are, preferably, expected to appreciate. The charity of your choice receives a fixed annual payout from the trust, and the remainder goes to your family members at the end of the charity’s payout term.

Unlike charitable remainder trusts, charitable lead trusts are not tax-exempt. However, tax implications differ between a grantor CLT and a non-grantor CLT. With a grantor CLT, you are treated as the trust’s owner for income tax purposes and are responsible for paying taxes on the income generated. However, there is the potential to receive an immediate charitable income tax deduction for a portion of your contribution to the CLT. In the case of a non-grantor CLT, on the other hand, no upfront charitable deduction is allowed for income tax purposes. However, the CLT itself receives a charitable income tax deduction each year for the qualifying distribution it makes to charity. The primary benefit of a CLT lies in its potential gift-tax advantages. The value of the donor’s initial gift to the trust is determined by three factors: a government-set interest rate, the length of the trust and the payout to charity. When the government-set interest rate is low, the value of the donor’s gift is reduced for gift tax purposes. So CLTs are particularly attractive in periods of low interest rates.

The Grantor Retained Annuity Trust
A Grantor Retained Annuity Trust allows you to pass assets you believe will appreciate in value to family members at discounted levels. You contribute assets to a trust and receive a fixed annuity payment stream for a specified period of years. At the end of the trust term, the remaining assets and their appreciation (if any) are distributed to your beneficiaries. Since the value of the gift is reduced by the present value of the annuity payments, you could structure a payment schedule and payout amount that could result in a minimal gift-tax value. However, if you die before the end of the specified term, some or all of the remaining trust property would be included in your estate and subject to estate taxes.

Life Insurance
You could use life insurance to help replace your estate and gift tax liabilities. Life insurance often provides a substantial benefit for relatively small costs. A life insurance policy may be used by itself to increase the size of your estate, or it may be used for cost-effectively paying estate taxes. Plus, the proceeds of life insurance are typically income-tax free to the beneficiary. And with careful planning, these proceeds may also be received estate tax-free.

The Limited Liability Company or Family Limited Partnership
A Limited Liability Company or Family Limited Partnership may help reduce the size of your estate for transfer-tax purposes. The LLC or FLP is made up of managing or voting interests and nonvoting interests, and you could gift the nonvoting interests to your children and grandchildren . Since the non-voting interests gifted to your children and grandchildren lack voting rights and are not readily marketable, they might be discounted for gift tax valuation purposes .

The Dynasty Trust
A Dynasty Trust could allow you to establish a source of funds for multiple generations. Here’s how it generally works: You would fund the trust with an amount up to your and your spouse’s lifetime gift tax exclusions. The trust assets, including any growth, will remain free of federal transfer taxes (i.e., estate, gift and generation-skipping transfer taxes) for as long as they remain in the trust. In certain states, such as South Dakota, the trust may theoretically last forever. And the plan could be designed so that any distribution from the Dynasty Trust would be free of gift- and generation-skipping transfer taxes.

Income or principal from the trust may be distributed to your children, grandchildren and great grandchildren as specified in the trust document. The provisions could tie those distributions to incentives, such as maintaining gainful employment, and permit distributions for funding businesses or purchasing homes for the use of beneficiaries or other activities. There also may be provisions in the trust document to gift a percentage of the assets directly to a charity or family foundation. Assets remaining in the trust are protected from creditors and divorce judgments.

Create Your Estate Plan
Discuss your estate planning objectives and concerns with your Financial Advisor and your tax and legal advisors. Together, you can develop an estate plan that best addresses your financial and familial situations.

Graeme H. Patey is a Financial Advisor located in Cleveland, Ohio and may be reached at 216-523-3015.

Life insurance is medically underwritten. You should not cancel your current coverage until your new coverage is in force. A change in policy may be subject to additional insurance and investment-related fees as well as increased risks, and may also require a medical exam. New surrender charges may be imposed with a new contract or may increase the period of time for which the surrender charges apply. Surrenders may be taxable. You should consult your own tax advisors regarding tax liability on surrenders.

Citigroup Inc., its affiliates, and its employees are not in the business of providing tax or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the “promotion or marketing” of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.

INVESTMENTS AND INSURANCE PRODUCTS: NOT FDIC INSURED • NOT A BANK DEPOSIT • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NO BANK GUARANTEE • MAY LOSE VALUE

Smith Barney is a division and service mark of Citigroup Global Markets Inc. Member SIPC.

Six Critical Risks in Financial Instruments

A good working definition of financial risk can be found on http://www.investopedia.com: “…the chance that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured using the historical returns or average returns for a specific investment.”

With that definition as a starting point, let’s look at the key components of financial risk. It’s important to take all of them into account when deciding on investing your hard-earned money.

Volatility

Volatility risk measures how much the value of an asset will deviate from the principal committed to that asset. This volatility is measured using a statistical concept known as standard deviation. Standard deviation predicts how much the value of an asset will deviate from its current value, based on historical data, within a certain degree of confidence.

Example: If over the last 10 years a financial asset has a standard deviation of 20 percent, we can assume there is a 67 percent possibility that it will fluctuate plus or minus 20 percent in the future. The big “if,” of course, is that the asset will follow its established historical pattern.

The more volatile an asset, the riskier it should be considered. When there is a high probability of fluctuation, it’s appropriate to demand a higher return to compensate for that risk.

Inflation risk

There is the risk that the dollar you receive in the future will be worth much less than it is today. You measure inflation risk through the real rate of return. If inflation is running at a 5 percent annual rate and you have your money sitting in the bank earning 3 percent, then your real return is a minus 2 percent. Inflation is eating away two cents for each dollar you’ve “saved.”

Now, here is a teaser: If you don’t know where the inflation rate is heading, would you call a savings account deposit an investment or a speculation? Is the interest rate you get on checking deposits a bargain? And what about the rate they promise on Certificates of Deposit? Are you investing or speculating, given what you now know about inflation-rate risk?

Interest-rate risk

Interest-rate risk most often applies to fixed-rate instruments such as bonds, but keep in mind that interest rates affect the cost of money. Since companies’ earnings can be affected by high costs of financing, up-or-down movement in interest rates will also impact share prices, or any other financial asset with a value that hinges on current interest rates.

All else being equal, if interest rates increase the price of bonds will fall, and if rates decrease the price will increase. Thus, if you buy a bond, you can expect its price to fluctuate until the maturity date, as would a stock until you sell it.

If interest rates rise after you buy one, a bond issued later will become more appealing, since it will offer coupon rates more in line with the higher rate. Since markets cannot change the coupon rate, adjusting the price of the bond can adjust the yield expected-bringing the expected return more in line with the higher rates.

Here is where interest risk comes into play. The bond you bought that pays a lower coupon rate will decrease in price, and as a result will show a principal loss on paper. In contrast, if interest rates decrease, your bond will increase in price, so you will show a gain on paper.

Credit or default risk

When you buy a corporate bond you are also exposed to what is known as credit or default risk. A bond is a debt instrument that amounts to a contractual agreement between the bond holder and the company that issued it. The company promises to pay interest and return the principal at a certain date in the future (called the maturity date).

What if a company can no longer fulfill its obligations to debt holders or creditors? In that case, the company will likely file for bankruptcy protection and the bond’s contractual agreement to pay interest and return the principal will no longer apply. Thus, credit or default risk means you will no longer receive the cash flow you expected and there is a high probability that you will not get 100 percent of your committed principal back.

Market or systemic risk

Then there is market risk. This risk, also known as systemic risk, is the risk that exposes your holdings to the daily up-and-down uncertainties of the markets. When there is a significant break in the positive trend of a market, your positions will be affected just because the market in general is being affected.

Examples include the aftermath of the tragic events of 9/11 and the current economic crisis, as the financial sector reacts to federal intervention in the bailout of investment banks caught in the fallout from the sub-prime mortgage collapse.

Market risk is not limited to stocks. It applies to all sorts of financial assets, including real estate, bonds from corporate or government issuers and commodities. Note however that market risk is not always negative. As shares move along the market – as measured by an index – they can move to the upside, too.

Liquidity risk

When you try to sell a financial asset and cannot find a buyer who will pay an acceptable price, you have just bumped up against liquidity risk. It is defined as the risk to which you are exposed when trying to sell a financial asset. The lack of buyers or interested parties may prevent you from selling the asset at a favorable price. In fact, if you must sell at any price, you most likely will realize a loss.

To allow for the possibility that you will not have immediate access to funds if you decide to “cash in your chips” when buying illiquid assets, you should adjust the expected return on these assets upwards to compensate for the lack of liquidity. Rule of thumb: The return expected should be significantly higher than a U. S. Treasury note.

Country and other risk

Country risk takes into account that an investor, speculator or corporate entity may lose all or part of its principal or capital expenditure when expanding operations outside its home country. This loss could be attributable to the economic environment or political actions such as nationalization of the company, forced confiscation of assets, or repudiation of debt. One example: The attorneys for Exxon, are now dealing with a $12 billion lawsuit against Venezuela for freezing the company’s assets.

There are of course, many other risks to which we are exposed. Unexpected and rare events that result from exposure to blind risks are called “Black Swan” events. A Black Swan event gets its name from the long and firmly held belief that swans came in only one color – white – and any other color variation was genetically impossible – until black swans were discovered in Australia.

Risk is a fascinating concept that is intrinsically related to what separates investment from speculation and speculation from outright gambling. The fact is that if you want to make money or, for that matter, succeed in life, you need to take chances. The important thing is to understand those risks and enter into any sort of investment with your eyes open.

Overview of Indian Financial System

Overview of Indian Financial System

Introduction

The Finance is the science of money manages- ment. We can say that finance is something related to manage – ment of money and other assets. Finance represents the resources by way funds needed for a particular activity. Finance is also referred to as “Funds” or “Capital”, when referring to the financial needs of a corporate body. Now you can finance anything that you want for example you can have home loans, business loans, education economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

The word “system”, in the term “financial system”, implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation. These are briefly discussed below;

Financial system overview

A Financial Market can be defined as the market in which financial assets are created or transferred. As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend.

Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions.

Capital Market – The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year.

Forex Market – The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe.

Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals.

Financial Intermediaries-

Having designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. To serve this purpose, financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a widerange of institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in move than one market e.g. underwriter. However, the services offered by them vary from one market to another.

Intermediary – Market-Role

Stock Exchange -Capital Market -Secondary Market to securities

Investment Bankers – capital Market, credit Market – corporate advisory services, Issue of securities

Registrars,Depositories,custodian – Capital Market – Issue securities management

Primary dealers satellite Dealers – Money Market – share transfer activity market making for govt.

Forex Dealers – Forex Market – Ensure exchange ink currencies

Financial tools-

Money Market Tools-

The money market can be defined as a market for short-term money and financial assets that are near substitutes for money. The term short-term means generally a period upto one year and near substitutes to money is used to denote any financial asset which can be quickly converted into money with minimum transaction cost.

Some of the important money market instruments are briefly discussed below;

1.Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

1. Call /Notice-Money Market

Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is “Call Money”. When money is borrowed or lent for more than a day and up to 14 days, it is “Notice Money”. No collateral security is required to cover these transactions.

2. Inter-Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

3. Treasury Bills.

Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

4. Certificate of Deposits

Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in dematerialized form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial papers and interoperate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

5. Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP provided – (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.

The capital market generally consists of the following long term period i.e., more than one year period, financial instruments; in the equity segment Equity shares, preference shares, convertible preference shares, non-convertible preference shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.

Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc.

In India money market is regulated by Reserve bank of India and Securities Exchange Board of India (SEBI) regulates capital market. Capital market consists of primary market and secondary market. All Initial Public Offerings comes under the primary market and all secondary market transactions deals in secondary market. Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Secondary market comprises of equity markets and the debt markets. In the secondary market transactions BSE and NSE plays a great role in exchange of capital market instruments.

Conclusion-

Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. Financial system is An information system, comprised of one or more applications, that is used for any of the following: collecting, processing, maintaining, transmitting, and reporting data about financial events supporting financial planning or budgeting activities; accumulating and reporting cost information.

References-

1. Economic times.

2. Business world.

Chinmoy ghosh.

Lecturer Accounting and Finance.

Islamic Financial Arrangements Used in Islamic Banking

Islamic financial arrangements used in Islamic banking

(MUSHARIKA, MURABIHA, QARDE AL’HASANA, IJAREH, MUDARABA)

Author: EHSAN ZARROKH

ZARROKH2007@YAHOO.COM

2007-04-06

ABSTRACT

Islamic finance is an old concept but a very young discipline in the academic sense. It lacks the required extent and level of theories and models needed for expansion and implementation of the framework provided by Islam. In these circumstances, unawareness and confusion exist as to the form of the Islamic financial system and instruments.

The main difference between the present economic system and the Islamic economic system is that the later is based on keeping in view certain social objectives for the benefit of human beings and society. Islam, through its various principles, guides human life and ensures free enterprise and trade. That is the reason why the conventional banker does not have to be concerned with the moral implications of the business venture for which money is lent.

TABLE OF CONTENTS

1. ABSTRACT

2. The Role of Money

3. Types of Islamic Financial Instruments

4. Risk Mitigating Features

5. Islamic Leasing

7. MUSHARIKA

8. MODARABA

9. CONCLUSIONS

Socio-economic justice is central to the Islamic way of life. Every religion has the same basic aim. In an Islamic environment, an individual not only lives for himself, but his scope of activities and responsibilities extend beyond him to the welfare and interests of society at large. The KORAN is very precise and clear on this issue. There are basically three components of an Islamic economic paradigm:

1. That as vice-regent, man should seek the bounties of the land that God has bestowed on humanity. From the wealth thus obtained, he should enjoy his own share.

2. That he should be magnanimous to others and use a part of the wealth so obtained also for the benefit of his fellow-beings.

3. That his actions should not be willfully damaging to his fellow-beings.

Human society in Islam is based upon the validity of law, of life and the validity of mankind. All these are natural corollaries of the faith. Islamic laws promote the welfare of people by safeguarding their faith, life, intellect, property and their posterity. God nurtures, nourishes, sustains, develops and leads humanity towards perfection. Even though an individual may be making a living because of his efforts, he is not the only one contributing towards that living. There are a number of divine inputs into this effort and therefore, the results of such an effort obviously cannot be construed as entirely proprietary.

Whereas the Islamic banker has a much greater responsibility. This leads us to a very fundamental concept of the Islamic financial system i.e. the relation of investors to the institution is that of partners whereas that of conventional banking is that of creditor-investor.

The Islamic financial system is based on equity whereas the conventional banking system is loan based. Islam is not against the earning of money. In fact, Islam prohibits earning of money through unfair trading practices and other activities that are socially harmful in one way or another. [1]

Those who swallow down usury cannot arise except as one whom SHAITAN (evil) has prostrated by (his) touch does rise. That is because they say, trading is only like usury; and Allah has allowed trading and forbidden usury. To whomsoever then the admonition has come from his Lord, then he desists, he shall have what has already passed, and his affair is in the hands of Allah; and whoever returns (to it) – these are the inmates of the fire; they shall abide in it [SURAH 2:275].

Not that there was any ambiguity in the Command of Allah. Far be it from Him to give any order to His Servants, which they can not comprehend. The fact is that those who had surplus money and wanted to earn profit did so either by lending it through RIBA (usury) or by investing it in trade and hypocrites were not prepared to forgo the first option. Hence, they argued that since both were means of earning profit, they were alike and the prohibition of RIBA did not stand to reason.

The practice of RIBA i.e. usury was so deep-rooted in society and continuance of the practice was so undesirable, that Allah warned the believers that if they did not desist, they should be prepared for a war against Allah and His Apostle. This warning was heeded by the Muslim UMMAH and for more than a thousand years the economies of Muslim states were free from RIBA. With the ascendancy of Western influence and its suzerainty over Muslim states, the position changed and an interest-based economy became acceptable. Efforts in Muslim countries to revert to an interest-free economy were hampered by many obstacles. [2]

The Role of Money

The traditional definition of the time value of money leads one to assume that profit maximization is the objective of investors irrespective of whether or not the earning of profit has made someone else worse off. Some economists have termed the maximization of profit as the sole objective of corporations. This view cannot be supported or defended since the profit maximization process may lead to perverse outcomes. When financial operations are removed of moralistic tone, competitive markets fail to achieve the efficient allocation of a country’s resources.

In Islam money in itself is not considered, as actual capital only exists when money, along with other resources, is sunk into productive activities. Linking the use of money to productive purposes invariably brings into action the factor of labor, a process from which benefits pass on to society.

Types of Islamic Financial Instruments

Demand for monetary instruments is influenced by the variation and level in the market rate what is meant as the market rate of return. The demand for household monetary instruments is mainly for the purpose of circulation of income. Banks need these instruments for:

1. Transaction purposes;

2. Precautionary purposes, in that some unexpected payments have to be made while some expected inflows may not be forthcoming on their due date, and;

3. not only to avoid loss but also to obtain gains in the capital value of financial assets under the expectation that the market rate of return may move in a certain direction.

What differentiates a traditional financial market from others markets is that no tangible good or service is exchanged for any monetary consideration; only a “financial claim” changes hands in the form of a promissory note or a title to any future flow of income adjusted for any capital appreciation. Not all Islamic instruments are purely financial claims. Some of the instruments also represent ownership of the underlying assets together with a claim to underlying cash flows. Basically there are the following four types of Islamic financial instruments:

1. Type “A” is a financial claim of monetary value with recourse to underlying durable assets and related cash flows. This type has a predictable future income stream, is marketable and can be discounted since with the changing of hands, the instrument passes title to the goods and not to the debt. It is basically lease-based.

2. This instrument is partly backed by durable assets and its income is not predictable, but evaluated through an asset valuation process at the end of an agreed and declared duration. The underlying transactions can be a mix of IJARA, MODARABA, MUSHARAKA etc., contracts. This Type may be traded in the secondary market at its fair market price acceptable to the parties involved but not discounted.

3. Type “C” is purely a monetary claim to an expected income stream forthcoming from underlying commercial transactions. Income is evaluated through an asset-valuation process at the end of an agreed and declared period. A transaction of this type may comprise MORABAHA, ISTASNA etc., contracts which are debt claims against third parties in respect to actual commercial transactions. The Type may be traded at its face value declared at the end of each accounting period but cannot be discounted.

4. The Type “D” is purely a financial claim of monetary value but with recourse to certain precious metals such as gold, silver, platinum, etc., or commodities quoted on exchanges. The instrument entitles the holder to take delivery of the underlying asset but does not carry any attached revenue stream except that its price is pegged to the price of the underlying precious metal or commodity quoted at recognized international exchange rates. It can be traded but not discounted. [3]

Risk Mitigating Features

The phenomenon of risk plays a pervasive role in economic life. Without it, financial and capital markets would consist of the exchange of a single instrument each period, the communications industry would cease to exist in so far as this market is concerned and the profession of investment banking would be reduced to that of accounting. Risk is further segregated from uncertainty. A situation is said to involve risk if the randomness facing an economic agent can be expressed in terms of specific numerical probabilities (these probabilities may either be objectively specified, as with lottery tickets or else reflect the individual’s own subjective beliefs). Situations where the agent cannot (or does not) assign actual probabilities to alternative possible occurrences are said to involve uncertainty.

While it is not always true that a riskier asset will pay a higher average rate of return, it is usually return. Risk is an opportunity in financial markets and also a problem. Risk-averse investors require additional return to be at additional risk and, in effect, in a competitive market higher return is accompanied by higher risk. An investor evaluates an asset in terms of its marginal contribution to his/her portfolio.

The fundamental principal of valuation is that the value of any financial asset is the present value of the cash expected. The process requires two steps:

1. Estimating the cash flow, and;

2. Determining the appropriate interest rate that should be used to calculate the present value

The following are the SHARI’AH compliant risk mitigating features:

1. By prior arrangements in the instrument, the investing company, through its banker, would have a priori right in profit sharing up to an agreed upon ratio.

2. The profit will be paid on account on a monthly basis to the investing company as provided in the projected accounts.

3. The final accounting and settlement is accomplished at the end of the term of the instrument when the profit and loss accounts are finalized.

4. In order to mitigate the risk and as per the terms of the instrument, a TAKAFUL fund is established for the term of the instrument.

5. In this TAKAFUL fund where the invested company earmarks a part of their reserves for the TAKAFUL fund.

6. The investing company will contribute 1% of the invested amount.

7. This 1% contribution is made through an advance by the invested company on account of future profits.

8. In case of any loss during the tenancy of the instrument, it will be adjusted against the TAKAFUL fund.

9. The balance will be distributed between investor and at the end of the term of instrument.

10. Through a valuation, value of the investment would be established for the purpose of exercising the put option.

11. The investing company shall have the option to exercise its put option at the value price and the company shall buy this instrument. [4]

Islamic Leasing

But before describing leasing, as aforesaid, let me very briefly touch upon two of the basic or fundamental principles of Islamic finance in order to develop a premise for meaningful discussions on leasing.

1. It has to be asset-based financing:

The first fundamental principle of SHARI’AH is that as opposed to conventional monetary dealing, profit is generated when something having intrinsic utility is sold or offered for use. Money has no intrinsic value. As such dealing in money (same currency) cannot generate profit but a RIBA unless converted into real assets to deal with.

2. There has to be an element of risk:

The second basic element of SHARI’AH is that one cannot claim a profit or fee for a property/transaction, the risk of which was never borne by him.

Based on the above fundamental principles, the most ideal mode or instrument of financing in SHARI’AH are MUSHARAKA and MUDARABA followed by SALAM and ISTINSA.

MORABAHA and leasing are not originally modes of finance. However, to meet certain specific needs where ideal modes like MUSHARAKA or MUDARABA are not workable for whatever reasons, they have been reshaped and allowed in SHARI’AH subject to certain conditions.

1. Leasing described for leasing, IJARAH is an Arabic term with origins in Islamic FIQH, meaning to give something to rent. There are two types of IJAREH. One relates to employing or hiring the services of a person for wages whereas the second type relates to the hiring of any asset or property in order to reap its benefits without the transfer of ownership, or what is called in English “USUFRUKT”. The price or consideration of this is the rent.

It is the second type of IJAREH which is the subject matter of the discussion here because it is generally used as a form of investment and also as a means of finance.

As described earlier, in the light of the two basic cornerstones of SHARIA’H, leasing is a contract whereby usufruct rights to an asset are transferred by the owner, known as the lessor, to another person, known as the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of lease.

2. Lease as a mode of financing Strictly speaking leasing is not a means of finance as originally envisaged. It is simply a transaction much as a sale/purchase. As described above, the leasing transaction simply denotes the transfer of the usufruct of a property from one person to another for an agreed-upon price called rent without transferring the corpus i.e. ownership of that asset. Accordingly, the rules of “leasing” closely resemble the rules governing “sale” because in both cases something is transferred to second person for valuable consideration.

Leasing differs from sale only in-so-much-as not transferring the corpus or ownership of the property which remains with the transferor. As such in SHARIA’H, a lease transaction is governed by a separate set of rules, which we shall outline in the following paragraphs.

Although leasing, as originally conceived, is not a means of finance, the financial institutions and the corporate world have adopted it as such. Due to several factors (including tax concessions, etc.), instead of providing an interest-bearing loan, certain financial institutions in the West started to provide requisite equipment to their customers. To arrive at the rent, the total cost of the asset is calculated plus interest or mark-up to be recovered during the period of lease on a monthly or quarterly basis. This type of lease in the West is known as a finance lease, to be distinguished from an operating lease, wherein various basic features of the leasing transaction are ignored which is tantamount to RIBA.

Knowing that leasing is lawfully allowed under SHARIA’H, since it meets one of the basic criteria of asset-based finance, a number of Islamic financial institutions have adopted leasing on this model as carried out by conventional financial institutions without making the necessary modifications that really conform to the rules under SHARIA’H, particularly in regards to assuming the risk of ownership in the leased asset. Great care needs to be exercised to ensure various SHARIA’H requirements, as rendered below, based on the basic two principles of:

1. Asset based finance, and;

2. Assuming a risk element connected to the ownership of the asset.

3. Basic Rules of Leasing

The description or definition given above, under part A, contains the following essential ingredients for outlining the basic rules under SHARIA’H:

1. That it is a contractual obligation.

2. That there has to be a valuable use of the asset and transferability of that usufruct.

3. That the ownership of the asset is retained by the transferor or lessor throughout the lease period. Consumable articles cannot be leased.

4. That the risk and liabilities of ownership lie with the lessor. The leased asset shall remain the risk of the lessor throughout the lease period. Any loss or harm caused by factors beyond the control of the lessee shall be borne by the lessor. However, the lessee is liable to compensate the lessor for any harm to the leased asset caused by any misuse or negligence on the part of the lessee.

5. That the risk and liabilities associated with the use of the asset shall be borne by the lessee. For instance, taxes and other government levies, utilities, etc. However, the contract must specify these items for clarity’s sake.

6. That the term of the lease, period of the lease, its renewal or early termination must be stipulated.

7. Purpose of use. The lessee cannot use the leased assets other than for the purpose specified in the contract or agreed to by the lessor expressly.

8. Commencement of lease. The lease commences from the date of delivery of the asset to the lessee and not from the day of payment or lease agreement, with reference to the commencement of rentals.

9. Determination of rental. The rent for the entire period of the lease must be determined at the time of the contract. Different rates of rent for different phases during the lease period are permissible. This point will be elaborated in the following discussion of the issues.

4. Issues

While operating a leasing business, a number of practical issues have cropped up which warrant discussion and interpretation under SHARIA’H. An exhaustive and conclusive list of such issues is impossible to make. However, certain important and salient issues need to be taken up in these discussions as follows:

1. Joint ownership (Lessors)/Joint Lessees – (permissible)

2. Insurance – Islamic TAKAFUL – (by the owner)

3. Renewal of or variation in the lease period – (permissible if mutually agreed-upon)

4. Future date. Agreement to commence lease on some future date is allowed. However, the rent has to commence from the date of delivery. If the lessee has paid the price and delivery of the asset is delayed by the supplier, then no rent is liable to be paid for the period of delay. It must be noted that future or forward sale in sale/purchase transaction is not permissible in SHARIA’H. This is another major point after ownership transfer which differentiates leasing from a sale/purchase transaction under SHARIA’H.

5. Acquisition of an asset by the lessee. For various reasons, the asset subject to lease may be acquired by the lessee and payment may be disbursed? Through him by the lessor. This is permissible under SHARIA’H on the principles of agent and principal. Here there are two relationships separate from and independent of one and other. The first relationship is that before becoming a lessee, an individual acts as an agent for and behalf of the lessor to acquire the asset. This is an independent arrangement. Once the asset has been acquired with all the risk and reward of ownership to the lessor, then a second relationship is created i.e. the lessor and the lessee under the lease agreement. That cost of acquisition shall be borne by the lessor being owner and not by the lessee.

6. Rentals.

1. Advance rentals are admissible subject to the condition of adjustment against the actual rental when due upon commencement of the lease as discussed before.

2. Unilateral increase by the lessor is not permissible even if stipulated in the contract.

3. Bench marks. The fixing of any bench mark for determining the amount of rent, as with an inflation index etc., is permissible provided that the lease agreement clearly stipulates the same e.g. if the inflation rate as declared by an authoritative body like the State Bank etc. is said to be 10% per annum, then the rent can be increased every year by that percentage.

7. Penalty for late payment of rentals. Penalty or compensation for late payment is not permissible. Rentals once due become a debt obligation or monetary asset which cannot generate profit under SHARIA’H. This situation has been exploited by unscrupulous lessees. In such circumstances, contemporary scholars have provided a solution whereby a penalty can be charged to the lessee for delayed payment though the amount recovered is only to be used for charitable purposes by the lessor. In other words, the late payment charges cannot be taken as income by the lessor. A suitable clause, therefore, is to be incorporated into the lease agreement to avoid any misunderstanding in this regard.

8. Premature termination of lease. Premature termination of lease is allowed provided that the lessee has violated or contravened the terms of the lease or it is by mutual consent of the lessee and the lessor. Any unilateral or unconditional termination of the lease either by the lessor or the lessee without prior notification is contrary to the principles of justice and equity, hence not allowed under SHARIA’H.

9. Repossession of an asset. In the event of early termination, or upon maturity of the term of lease, assets have to return to the lessor unless he voluntarily relinquishes his rights or makes a gift of the leased assets to the lessee. However, rent would be payable only up to the date of termination and not beyond. Entitlement or the right of the lessor to claim rent from any period after termination, even if expressly stipulated in the contract, is not valid under SHARIA’H.

10. Residual value. It is accepted under SHARIA’H that ownership of the asset belongs to the lessor and, therefore, assets should revert back to him upon expiry of the lease. Any stipulation to the contrary in the contract that the lessor can sell or transfer the asset to the lessee upon the expiry of the term of the lease at a pre-determined price called residual value is not considered valid from the point of view of SHARIA’H However, this point is currently a subject matter of debate among contemporary scholars. They are of the view that if a lessor unilaterally undertakes or promises to transfer the ownership to the lessee as a gift or at a token price separate from the lease agreement, then this can be considered validly binding on the lessor at the option of the lessee.

11. What is important is that under SHARIA’H the leasing and sale/purchase transactions are two separate things and should not be mixed up in one contract, as both are independent and governed by separate rules. Nothing, however, in SHARIA’H stops the lessor from giving away the ownership of his assets at his own discretion or good will toward the lessee at any mutually agreed-upon price or as a gift upon the expiry of the leasing contract.

12. Sale and lease back. This is allowed, but only as two separate transactions. That in the first place there is a sale of assets to be purchased by the lessor. This is governed by SHARIA’H rules of sale/purchase at a fair market value. Once the ownership title is validly passed on to the lessee, a lease transaction can then be executed separately through a lease agreement.

13. Sub-lease. Sub-lease by the lessee is permissible under SHARIA’H subject to the consent of the lessor and can be expressly outlined in the lease agreement. In SHARIA’H, however, there are divergent views if the rent arising from the sub-lease is higher than the rent payable on the original lease. Some scholars allow the differential to be retained by the lessee while others feel that the surplus received from the sub-lease should be passed on to the owner i.e. main lessor.

14. Assigning of the lease. Also permissible under SHARIA’H, the lessor can sell the leased assets to a third party along with his rights and obligations. The relationship between lessor and lessee in this case will be determined between the new owner and the lessee. However, the lessor cannot assign the lease without transferring the ownership for monetary consideration. Here the basic SHARIA’H cornerstone of asset-back transaction is not there. Rent receivables are debt obligation which cannot therefore be transacted for a monetary price. Assignment of lease rentals without monetary consideration is, however, not prohibited in SHARIA’H.

15. Securing of the lease. Leased assets can be secured along the same principles governing the assignment i.e. ownership of assets along with the rent. Rent alone without ownership of the assets cannot be secured for the reason of being a debt obligation as discussed before. Securing a lease can be made wholly or partly to one party or to a number of persons. Documentation has to be carefully prepared to ensure the securing instrument represents assets and not the debt or monetary obligation alone. [5]

Some Difficulties

Major hurdles faced by Islamic finance houses are the absence of a necessary legal framework and the lack of adequate infrastructure in the banking and investment fields. [6]

The modern banking system is based on the concept that money should be treated like any other factor of production and must earn some return over a period of time. It is argued that the establishment of large-scale enterprises, and hence material progress, is not possible unless there is an agency that can mobilize financial resources from the public by paying them some interest, while lending these resources to entrepreneurs. By charging these entrepreneurs a higher interest, these agencies were able to utilize the difference (called a spread) to meet their expenses and to make some profit for the owners of the agency (i.e. share-holders). Banks were established to fulfill this need and from the beginning were only authorized to perform this function. They were legally prohibited from entering into trade or industry. When the Government of IRAN decided to introduce an interest-free banking system, this prohibition was removed. After a lot of in-house the banks were told that they were allowed to deal in only 1 to 12 means of financing (only two were classified as “Financing by Lending”).

These two permitted lending without interest by charging the actual expense incurred by the banks to meet their cost of operation and QARDE AL’HASANA. All the rest were either trade-related or investment-type models. These included the purchase of goods by banks and their sale to clients at an appropriate mark-up price on a deferred payment basis, in case of default there being no further mark-up. This sale of goods on mark-up is known as MURABIHA. Other types of financing were hire-purchase, leasing, MUSHARIKA or profit- and-loss-sharing, equity participation and purchase of shares, etc.

Since MURABIHA was the type nearest to lending and since it did not require any expertise in buying and selling commodities, bankers limited most of their financing to this type. In order to eliminate the risk of prospective buyers refusing to accept goods purchased by the banks by reason of not being strictly in accordance with the specifications, banks were allowed to appoint the prospective buyer as their agent for the purchase of the goods and later for the sale of the goods to the buyer’s firm. Furthermore, to give as much leeway to the banks, as safeguards of public money, as possible, the ULAMA did not fix a waiting period between the two stages of buying and selling.

The banks did not assume the role of trader and MORABIHA degenerated into lending on mark-up. The banks rarely hired persons who knew even the basics of trading, nor did they train their existing staff to learn the art. They did not even bother to find out whether their agents had actually purchased the goods or not. The inability or reluctance of banks and financial institutions to change over their operations from lending to trading has been a serious impediment to the Islamisation of the economy.

The blame does not entirely fall on the bankers. Depositors have become so accustomed to their money remaining safe and yet earning profit that if a bank had really ventured to trade and incurred a slight loss, then the depositors would have immediately demanded their money back causing the bank to go bankrupt. In the existing state of morality this was more likely to happen. It actually did happen to a few investment companies that had started with good intention, but could not go on giving away handsome profits to their depositors.

A lack of seriousness and dedication in those responsible for the implementation was also another great impediment to the achievement the goal of an interest-free economy. Many of these individuals thought that in the present world, there was no alternative to interest, yet something had to be done because of demands from the government. Some, who were more influenced by Western education and culture, thought that interest banking was not prohibited by Islam. Yet others thought that the efforts being made were only superficial and in reality the new system was no different from the existing system.

One weakness in the implementation of the proposals to eliminate interest from the system was that people were not sufficiently motivated to sacrifice a part of their financial interests for the sake of carrying out the commands of Allah (SWT), and the Prophet (SAW). Anyone attempting to change a well-established practice must be prepared to make some sacrifice for this, as arguably no noble cause has been achieved without any sacrifice. The prevailing level of public morality within the existing legal and taxation system of the state made it an up-hill struggle to rid the banking system of interest. And it remains so. Beyond this, there are many avenues of making profit that would have to be forgone and many types of modern banking services which also could not be provided by a bank working strictly on Islamic principles. For example, they could not keep their surplus cash in fixed or saving deposits. In spite of these difficulties, those who were engaged in the task of Islamisation took it upon themselves to portray as successful the reforms, while those who pointed out the difficulties were labeled as either a cynic or an opponent of the new system. Anyone who uttered a word of caution was regarded as someone who did not want the experiment of Islamisation to succeed. As a matter of fact, reward in the Hereafter (AAKHIRAT) should have been the main purpose of Islamisation. It might not have attracted many people, but the foundation would have been firm.

One great obstacle in the realisation of the goal of an interest-free economy has been absence of a proper environment. Unfortunately nothing has been done to produce an ideal or a near ideal Islamic environment by government or public leaders. The most important pre-requisite for the enforcement of SHARIA’H is A’DL [translation!!!!!!]. Establishment of the rule of law and ensuring justice to aggrieved persons should be the first task of an Islamic state, yet nothing have been done to achieve this end.

One very important requirement of an ideal environment is an inflation-free economy. Inflation erodes the real value of money, meaning that when a person gives a sum of money on loan and receives the same amount back after one year, he has made a net loss. A major source of inflation is deficit financing. The printing of notes to meet budgetary deficit is in fact an injustice to the public, since the real value of their money is consequently eroded. In this respect too, the government’s performance is very discouraging. Government borrowings at high interest rates and the quantum of the government’s domestic and foreign debts has reached a level which cannot be sustained. There has also been no effort to change the taxation structure so as to bring it to conform to SHARIA’H. [7]

MUSHARIKA

MUSHARIKA represents the most desirable form of Islamic financing arrangements. Yet, in terms of its ability to be an effective and efficient instrument for replacing interest-based transactions, it poses formidable problems.

The salient features of the MUSHARIKA agreement, as practiced by the commercial banks, were as follows:

1. It was a short-term financing arrangement specific only to the parties to the contract.

2. Investment by the banks was made in the form of the sanctioning of a funding limit to the client and the degree of employment of funds was determined on the basis of daily product of outstanding balances due to the bank.

3. All participative funds, including equity, reserves and other non-debt capital was included in the definition of capital qualifying for profits.

4. Profit sharing ratio was determined through negotiations within the boundaries specified by the SBP.

5. Profits for the purpose of sharing were to be determined after apportioning a share of net-income as a management fee to the firm.

6. Provisional profits, based on projected profits, were to be paid to the bank on quarterly basis, subject to a final adjustment on the basis of actual profits or losses.

7. Shortfalls or excess profits were to be settled through the creation of a [participation] reserve fund, which would attempt to smooth out the payments to the bank.

8. Losses, if any, were to be shared in strict proportion to the bank’s investment in the total capital of the firm.

9. Against the apportioned loss of the bank, ordinary shares were to be issued, which qualified for recon version in MUSHARIKA investment under the original terms of the agreement in case profits accrued in future.

10. Standard securities in the form of pledging and hypothecation stocks or the mortgaging of properties were required against MUSHARIKA financing.

Some of these features of the instrument attracted criticism. For example, the profit sharing arrangement did not strictly conform to the requirements of SHARIA’H particularly in the treatment of losses and the payment of provisional profits or their adjustment through the participation reserve. Secondly, despite being a sharing arrangement, the actual agreement was cast within the framework of a creditor-debtor relationship, and was also protected as such in law. Three, MUSHARIKA also demanded securities which were akin to the relationship between a creditor and debtor. Finally, in the absence of a legal framework regulating the operation of MUSHARIKA, there was no standardization of the agreement, and the terms and conditions of various agreements varied considerably.

MODARABA

MODARABA represents another of the more desirable forms of Islamic financing arrangements.

The salient features of MODARABA companies and their operations are as follows:

1. Only registered companies or those established under specific laws are eligible to register as MODARABA companies.

2. MODARABA can either be specific purpose or multi-purpose and can either be for a fixed term or in perpetuity.

3. On fulfillment of certain conditions, and with the prior approval of the Registrar, MODARABA companies may float MODARABA on the stock exchange, and their certificates of issue will be tradable securities.

4. Each MODARABA will be a separate business and its operations must conform to those approved under the injunctions of SHARIA’H.

5. A Religious Board, to be periodically constituted under the ordinance, will be empowered to declare whether the operations of MODARABA were in conformity with the provisions of SHARIA’H or not.

6. Many disclosure requirements, similar to those applicable to listed companies, are applicable to MODARABAS, including statutory audit, annual meetings and investments and loans to and from the directors of the MODARABA Company.

Evidently, the entire scheme was an elegant formulation of the simple relationship required under a MODARABA contract between labor (DARIB) and capital (RABBULMA’L). The management company was to be remunerated through a fixed management fee paid out of the net income of the MODARABA and the remainder was to go to MODARABA certificate holders, with adequate provisions for retained earnings to ensure future growth.

CONCLUSIONS

To outline the broad features of a strategy which holds the promise of successfully implementing an Islamic system of finance are as follows:

1. The process has to be guided by basic legislative efforts covering all the essential elements of the proposed programmed.

2. The legislation would define RIBA and prohibit transactions connected with RIBA.

3. The application of the law would be unqualified and without exception, thus the entire financial sector, covering banking government finance and foreign transactions would be covered in its ambit.

4. Given the unqualified and non-exceptional nature of the proposed law, even existing relations will have to be converted into permissible forms, for which a suitable time frame, within a phasing-in period, will be allowed.

5. The law should also provide for the Constitution of a SHARIA’H Board which would assist the SBP to formulate permissible means of financing. Such means, specified with the prior approval of the Board, will only be illustrative and no restrictions will be placed on banks and financial institutions to design means of financing which are free of RIBA.

6. A major portion of the law will have to be devoted to a plan of restructuring the fiscal policy which comprises a scheme for the privatization of public sector assets and the use of its proceeds for the settlement of the outstanding stock of public debt.

The proposed strategy is based on the clear recognition of the scope implied by the prohibition of RIBA. This is critical, for otherwise the solution will continue to elude us.

Escape Financial Meltdown by Moving Assets Offshore Now

On September 19, the SEC suspended short selling for 799 financial companies to “protect the integrity and quality of the securities market and strengthen investor confidence“. Since then the Dow has lost 165 points. The ban ends tomorrow.

Eric Roseman says the legislation targets the wrong traders. Short sellers make the market more transparent. By blocking them, the SEC is violating the free market.

The ban has so far failed to stabilize the markets. Don’t be surprised if the government now moves to target other safe havens such as gold and offshore accounts. Eric recommends investors move quickly to secure their assets in European strongholds like Switzerland and Liechtenstein.

This from The Sovereign Society:

By targeting and banning short-sellers, the SEC is barking up the wrong tree and removing one of the last market-based sanctuaries in a dreadful year for financial assets.

This legislation won’t help the markets. In fact, it will ultimately create a new round of broad-based selling when the SEC finally lifts the bans.

This isn’t the first time a country has banned short selling.

Recently in June 2007, Pakistan banned short-selling practices. Now, just 15 months later, the market in Karachi is down by another third, so that obviously didn’t work.

England also banned short-selling in the 17th century following the collapse of the Dutch tulip mania. That effort also failed to calm the markets.

The SEC’s ban on financial stock short-selling is primarily why global stocks posted huge gains last Thursday and Friday. Short-sellers scrambled to cover their bearish bets or were forced to buy back the same stocks they were betting would continue declining.

This classic “short squeeze” won’t help alleviate market sentiment and points blame to the wrong segment of the market. If a company or sector should be valued at a lower multiple, then the government shouldn’t interfere in a free market. This response will only delay another day of reckoning as banks face mounting losses on traditional lending practices, including credit cards, auto loans, and other facets of lending.
We Short Because It Makes the System More Honest

Short-selling means you’re borrowing shares because you anticipate selling them in the future at a lower price. It allows you to be bearish on stocks that you don’t own. From a practical standpoint, short-selling also creates truth in an otherwise corrupt marketplace where some companies dodge accounting rules and fudge their books to hide losses.

The latest salvo fired at short-sellers this month targets the wrong group of traders. These short-sellers actually help to create liquidity in the markets and stem market bubbles.

Short-sellers try to honestly target aggressive accounting practices. And more often than not, these traders help create balance in an otherwise heavily manipulated market.

Short-sellers are also racking up the best returns in 2008 among diversified hedge fund strategies. By some accounts, short-sellers have gained more than 10% this year through August and they’re up 12.5% over the last 12 months. In September, estimates point to another 5% gain for this group, while traditional equity benchmarks have crashed by about a quarter.

One of the more respected short-selling specialist firms – Kynikos Associates in the United States – was one of the first firms to isolate questionable accounting at Enron. As I’m sure you heard, Enron CEOs were either prosecuted or heavily fined and will never be allowed to manage a public company again.
SEC Downgraded to Junk – Thanks to Chris Cox

SEC Chairman Christopher Cox has finally awakened from a deep sleep that lasted 13 months. Presidential candidate, John McCain, publicly denounced Cox last week claiming the first thing he would do if elected this fall is fire Chris Cox. I agree.

The SEC was literally asleep at the wheel until July. They were doing absolutely nothing to police aggressive accounting by financial company CEOs. And they did nothing to warn investors about suspicious accounting, aggressive sales practices involving mortgage-backed securities, or the bubble that inflated among mortgage offerings.

The other high-risk, dangerous securities, including collateralized debt obligations (CDOs), credit default swaps (CDSs), and other credit derivatives are not even regulated, let alone scrutinized by the SEC.

What was the SEC doing all this time as financial markets were hemorrhaging?

Instead of doing its job ensuring that U.S. capital markets are properly regulated, the SEC is now pointing fingers to short-sellers and blaming this highly skilled group of traders and analysts for the markets’ crash earlier last week.

Yet Cox, in a public statement earlier in his tenure claimed, “We need the shorts in the market for balance so we don’t have bubbles.”
Shorting Is American as Apple Pie

By banning short selling the government is effectively saying that it’s trying to determine where stock prices should settle. That’s not what a free market is about. This response damages the credibility of the free market system and ultimately suppresses the true value of an entity.

If the SEC and other governments can ban short-selling, then one has to wonder which segment of the market is next to face regulation or restrictions…
Is Gold Next?

In 1933, under Executive Order 6102, FDR confiscated gold ownership. Under extreme market circumstances governments can impose extraordinary measures that usually do not benefit the poor, unsuspecting investor.

The current financial crisis in the United States is the worst since the Great Depression and might warrant other measures that confiscate foreign currencies, precious metals, or other international assets and securities. Anything is possible.

As this crisis eventually fades or possibly gets worse, investors should use the offshore private bank account window before it closes. It’s still legal to move money to Europe. The best destinations for asset protection remain Switzerland, Liechtenstein, and Austria.

Having some gold stored in these European countries is a powerful safe-haven strategy amid extreme economic circumstances. It will give you the high margin of safety you’ll need to protect yourself from the next financial debacle.

PS: If you want to learn more about the threats to your deposits or how to move your money offshore, read on here.

Source: Escape Financial Meltdown By Moving Assets Offshore Now