Sharia Compliant “Possibility for Italian SMEs

Paolo Pietro Biancone, Maha Radwan

Abstract— Islamic Finance have been a flourishing phenomenon recently with a very high growth rates and countries worldwide are exerting efforts to introduce it as an alternative financial system especially after proving its stability in the last financial crisis. Introducing the Islamic finance in Italy would be very important step with high potential opportunities due to the creation of investment opportunities, increase of liquidity, accessing Arab sovereign funds, and promoting integration policies for immigrants. Understanding the current nature of the Italian companies in particular the Small and Medium Enterprises (SMEs) and by testing their eligibility of being Sharia compliant in this paper; which is a fundamental step for exploring the feasibility of adapting them to the Islamic financial system and therefore the possibility for financing them through Islamic financial instruments; had proved its validity with an optimal results whether on the screening process or the performance and profitability measures. Keywords; Islamic finance, Sharia Compliant, SMEs, Sharia Indices, Sharia Compliant Screening.

I. RESEARCH PROBLEM AND OBJECTIVES Small and Medium Enterprises (SMEs) are the basic stones in most of the economies. They contribute heavily to the economic growth worldwide. Most of the countries always try hardly to encourage development of SMEs as it contributes a lot not only to economic growth, capital accumulation but also through the employment opportunities that they create. This research aims to explore the feasibility of adapting Italian SMEs to the Islamic financial system and verify the possibility of financing them through Islamic financial instruments which requires certain aspects to be fulfilled. Applying this would require that the Italian SMEs to be a Sharia compliant. Objectives of the research are: – To test the Italian SMEs for Sharia compliant screening – To determine the eligibility of Italian SMEs to the Islamic finance – To evaluate the problematic criteria‟s that could prevent the SMEs from being eligible – Figuring out what are the suitable tools that Islamic finance could offer to SMEs II. INTRODUCTION AND LITERATURE REVIEW Islamic finance is, indeed, a growing sector with its diversity in different segments in various parts of the world. Although the Islamic finance industry started to flourish recently, Islamic theories of economics have existed for more than a millennium. However, only in the 20th century Muslim scholars and academics seriously started to revisit these topics; and this had been the beginning for the modern Islamic finance industry to emerge in the 1970s (Iqbal & Mirakhor 2011) [13]. Islamic finance has not taken root solely in Muslim countries but has also spread to non-Muslim countries. It is not serving only religious Muslims in Muslim‟s societies and Muslims in Western countries but also it started really to flourish as an ethical non risky attractive financial instrument for NonMuslim population. Islamic finance is a system for all financial transactions that are conducted according to Sharia which is the legislative framework that regulates all aspects of lifxe for Muslims; it governs all their public and private life. Sharia is derived directly from four main sources: 1) The Holy Quran; which is the Holy book that contains the words of Allah “God”. 2) Sunna; which refers to Hadith “sayings”, actions, of Prophet Mohamad “Messenger of Allah”. 3) Ijma; which is the consensus of all Muslim scholars on a specific issue. 4) Qiyas; means “Analogy” and this for the issues that were not explicitly mentioned either in Quran or in Sunna and consequently in this case it is declared by qualified scholars who evaluate a measurement through studying rules applied for similar issues. Islamic finance from an economic point of view refers to a system which identifies and promotes economic and financial orders that are consistent with the principles of Sharia [7]. These principles differentiate Islamic finance from the conventional finance. Specifically, Islamic principles require that Muslims earnings must come from permissible means, and must also be spent on acceptable categories of expenditure that are Sharia Compliant “adhering completely to Sharia principles”. Consequently, Islam prohibits investing in businesses that are considered unethical or contrary to the Islamic ethical teachings and values. Islamic economics is mainly concerned about the distribution of wealth as a mean for achieving justice, equality, fairness, and economic equilibrium among the society. Muslims are encouraged to maximize their wealth as long as they do not create a situation that is creating a social distortion or violating the norms of Islamic justice [4]. As a result the need for financial institutions, products and services, instruments and contracts that is compliant with Sharia and within the constraints of Islamic ethical principles. Sharia compliant institutions are similar to conventional financial intermediaries in that they are profit maximizing institutions and offer traditional banking services, but differ in some of the principles under which they operate [9]. Research from the International Monetary Fund (IMF) indicates that Islamic banking appears to be a complement to conventional banks, rather than a substitute. A core concept of finance in Islam is that Allah “God” is the owner of all wealth in the whole world, however at the same time; Muslims have the right to enjoy whatever wealth they acquire and spend it in Sharia compliant ways. The most important principles of Islamic finance include a prohibition for Riba “Usary”, prohibition of Gharar “uncertainty/speculation”, prohibition of Maysir “Gambling” and prohibition on investment in Non- Halal that is equivalent to Haram “unethical” businesses products or services (such as alcohol, tobacco, pork, adult entertainment, and weapons). Sharia compliant products must be backed by or based on an identifiable and tangible underlying asset; it is also important that the investor and investee adhere to the concept of profit and loss sharing which is in other terms sharing the risk of all financial transactions. Islamic Financial products, while they are derived from Islamic ethical laws, are not limited to Muslims population only but they are available to everybody. It is a technical financial system that is operating on an ethical basis that is very similar to the social responsibility investments that promotes for an ethical finance. Islamic Finance is considered to be the fastest growing sector of finance in the world. The Islamic finance industry has experienced in recent years (estimated at 10%-20% annual growth) [3]. Industry experts estimate that assets held under Islamic finance management doubled between 2007 and 2010 to each around $1 trillion [10]. A survey of the top 500 Islamic financial institutions shows that Sharia compliant assets in these institutions rose from $822 billion in 2009 to $895 billion in 2010. III. FUNDAMENTALS AND FINANCIAL INSTRUMENTS OF ISLAMIC FINANCE Islamic finance institutions operate with reference to principles of Sharia. Those principles have got specific characteristics and prohibitions that regulate it which are different from the traditional conventional financial institutions features. 1. Prohibition of Riba “Usury or Interest”: From a Sharia prospective, riba “interest” is considered to be usurious and is prohibited. Riba refers to the premium that must be paid by the borrower to the lender along with the principle amount as a condition for taking the loan. Scholars have classified riba into two types that could be seen in;  Inequality of quantity or weight and dissimilarity of quality exchanged between parties  The extension of the repayment period of a loan for additional amount of money. It makes no difference whether the loan is for consumption, or business purposes, or whether the return is a fixed or a variable percentage of the principal. It also makes no difference whether an absolute amount to be paid in advance or on maturity, or received in the form of a gift or a service if stipulated as a condition in the loan contract or an extension in its maturity” [2]. 2. Prohibition of Gharar “Uncertainty or Speculation”: Gharar “uncertainty” in Arabic refers to excessive risk, uncertainty and hazard. Gharar can be seen into two types: gharar in the object of the contract and gharar in the terms of the contract. The rationale behind the prohibition of gharar is that to ensure the full consent of all parties in a contract. 3. Prohibition of Maysir “Gambling”: Maysir in Arabic means gambling which is hazard game of chance and it is considered as an extreme form of gharar. It refers to all transactions that have the element of gambling i.e. based merely on chance. The logic behind the prohibition of maysir is that the unjustified gains and increase of wealth through games of pure chance is a transfer of wealth from one to another and this kind of transfer is done on the expense of the society. 4. Principle of Profit and Loss Sharing (PLS): The Islamic ethics and Sharia has encouraged the increase of wealth however this increment should be done with reference to a very important principle which is Profit and Loss Sharing (PLS). This principle specifically refers to an equitable sharing of risks and profits between the parties involved in a financial transaction. Earnings of profits or returns from assets are permitted as long as the business risks are shared by the lender and borrower.

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Islamic finance, Sharia Compliant, SMEs, Sharia Indices, Sharia Compliant Screening