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    Similarities and differences between Islamic and Ethical Finance

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    What are the differences and similarities between ethical finance and Islamic finance?

    1. I want to have knowledge of the facts and understand the related facts in a broader context about the mechanism of both ethical finance and Islamic finance, how they work.

    2. I will appreciate if this is backed by more references, preferably 5 references;

    3. How can I structure these ideas in an essay that have the following:

    • Introduction/ Abstract
    One paragraph as a condensed summary to the beginning of the paper under the title "Abstract/ Introduction"
    • Literature review:
    With summarized major ideas and references.
    State the idea about the subject matter showing the basic theory and background about both ethical finance and Islamic finance with comparisons and contrasts.
    Synthesize the ideas obtained and add some evaluation and comments.
    Give more detail on the topic with formulas, numerical examples, cases from both with comparisons and contrasts.
    • Arguments, formulas or examples in support of your statement
    Supported arguments that pays attention to reasons, numerical examples and cases and weighs arguments in favor and against a the stated facts. Elaborate and focus numerical examples with formulas,cases comparisons, graphics and statistics that help in showing what is meant keeping in mind that the controversial subject matter which has its equivalence in the ethical and Islamic finance.
    • Conclusion:
    Arguments supporting the statement to balance the arguments for and against this conclusion with comparison and contrast. What precautionary measures should Islamic financial institutions take to avoid non-compliance with Sharia showing the contribution of Islamic finance to the financial system and the economy at large.
    • Opinion:
    It is appropriate to add an assessment or opinion.

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    Solution Preview

    See the attached file.

    I. Introduction
    A). Islamic Finance
    Islamic Finance is an alternate philosophy to conventional finance that operates in accordance with the rules of the Sharia, known as Fiqh-al-Muamalat (Islamic rules on transactions). These rules are believed to be decreed by the Holy Prophet Mohammad himself in respose to the prevailing injustes and uncertainties of the era. The basic governing principles of Islamic Finance include sharing of the risk and rewards between counterparties, avoidance of usury, greed and surplus (referred to as Riba) and the avoidance of uncertainty or risk (referred to as Gharaar). These translate to the operating principles, the key ones among which include the following
    1. No interest income should be earned from investments in assets as these represent a surplus (Riba) over the true value of the asset.
    2. Under any exchange between counterparties, either the payment of consideration or the delivery of the goods must be performed. Furthermore, at least one of the counterparties must be present at the time of the exchange.
    3. The exchange must be for real commodities of a specified quantity. Thus trading in instruments such as currency derivatives, interest rates, exchange rates and stock index values are not permitted.
    4. No participation in activities that are forms of gambling, speculation or the like should be undertaken as these represent uncertainty or risk (Gharaar).
    5. No transaction should be undertaken which involves any interaction with individuals or firms that undertake activities that are considered sinful (Haraam). These include gambling, tobacco, arms manufacture, tobacco, pornography among others.
    6. Any commodity that is not in one's possession cannot be transacted with another party. In essence, this prohibits forward trading.
    7. One cannot take debt over a debt i.e. take debt (or obligation) to meet another debt (or obligation). Examples include not borrowing money to arrange for the production and delivery of an item as the production itself is an obligation on the producer.
    Financial products similar to those in conventional finance, such as home mortgage or insurance that are compliant with the Sharia have been developed and are being provided by Islamic Finance institutions. Some of these are illustrated below:
    1. Musharakah Mutanaqisah (Diminishing Partnership) home mortgage model -
    The home purchaser pays a percentage of the consideration value as down payment and takes possession by paying a rental instead of the conventional EMIs. The home purchaser may increase his ownership and gradually fully own the house by making payments in excess of the prescribed rent.
    Fig. 1: Schematic diagram of the Musharakah Mutanaqisah mode
    Source: researchguides.law.syr.edu
    2. The Takaful Wakala insurance model
    The Takaful wakala model relies on cooperation among policyholders who contribute money to a common pool. A management fee is taken from the policyholders' fund and is transferred to the shareholders' fund to meet the operating expenses.
    Fig. 2: Schematic diagram of the Takaful Wakala insurance model

    Source: anhe51.wordpress.com
    As per estimates, ...

    Solution Summary

    The solution reviews the background and origin of Islamic and Ethical Finance and compares the similarities and differences between the two.